A quick flashback on the last day of the year shows how crude prices have hurt the broader markets almost on a daily basis in 2015. It is quite natural that oil investors can only wish for a recovery in 2016. As we stand on the cusp of a New Year, let’s delve into the events that will likely play a bigger role in determining 2016 crude fate.
To start off, all we can say is that there is more or less no reason to keep expectations high for a miraculous oil price recovery.
A Recap
Let’s have a look at the oil price picture in the past. Since mid-2014, the commodity’s price has been plunging, primarily due to excess supply of crude in the global market.
To go back further in time, during 1990 and early 2000, the U.S. was more dependent on crude import as domestic demand was far above its conventional oil supply. But with the invention of new techniques like hydraulic fracturing and horizontal drilling, U.S. shale producers ramped up oil production relentlessly. Eventually, the U.S. started relying less on oil import thanks to the huge scale of crude output.
The shale boom turned the U.S. into an oil-surplus economy from a crude-deficit region. Along with the U.S., the Organization of the Petroleum Exporting Countries (OPEC) – the international cartel of oil producers – also pumped up more crude. All these events led to a global oversupply of the commodity and pushed oil to its multi-year lows.
The Whys and Wherefores
Now the question that arises is what stopped the big oil producers from reducing output in 2015 when the measure could have taken crude back to its glorious days as were seen in the first half of 2014.
Looking back, a war for market share has been raging among the likes of OPEC, the U.S. and Russia. Each of these markets has been pumping hard and competing for market share, completely ignoring the downtrend in oil price.
On top of that, at the recent meeting in Vienna, OPEC decided not to cut oil production. Instead, the cartel raised its production ceiling. Saudi Arabia-led OPEC explained that if it is the only block to curb output when other players continue to produce at their own lofty levels, it will end up losing market share.
This early-December decision dealt a huge blow to the energy market and dragged West Texas Intermediate (WTI) crude price further to below the $40-per-barrel mark. Even yesterday, oil closed at $36.60 per barrel.
Overall, the picture is not at all in favor of an oil price respite in 2016. We believe the major events that can determine the black gold’s fate are: Saudi Arabia-led OPEC’s production growth in an already oversupplied market, possible flood of Iranian oil, lift of the four-decade long U.S. crude export ban and the weakness in Chinese economy. Let’s go by these events one by one.
OPEC Says No to Production Cut: As already mentioned OPEC did not agree to curb oil output at the contentious Vienna meeting. The cartel decided to raise the ceiling of daily production from the prior level of 30 million barrels to 31.5 million barrels. This might be a reflection of Saudi Arabia’s intention to keep Iran − also a part of the cartel − under pressure after sanctions on the latter are lifted by early 2016.
In other words, Saudi Arabia wants to flood the already oversupplied crude market and wants to prolong the crude bearish trend. So, when Iran starts exporting oil, its revenue will have to pay for the low crude price.
On top of that, according to many analysts, OPEC also has an intention to keep high cost oil producers out of the market by consistently keeping the commodity price low for a stretch of time.
Lift of Oil Export Ban on Iran & U.S.: After months of negotiations, a nuclear deal was reached between Iran and six world powers by mid 2015. The agreement was meant to restrict Iran from manufacturing nuclear weapons in exchange of removing economic sanctions – which also included constraining crude oil export from Tehran. With this historic agreement, every road that led to manufacturing nuclear weapons in Iran has been blocked for at least 10 years.
But with the sanctions lifted likely by early 2016, Iran will start flooding the crude market, as the country depends heavily on oil export. Moreover, the lift of U.S crude export ban will add to the existing over-supplied oil market.
Weak Chinese Economy: China is the world's second-largest oil consumer. Persistent weakness in the Chinese economy weakened global crude demand to a large extent.
The slowdown in China is partly due to the shift of this most populous country to a consumer driven economy from one banking on manufacturing and exports. Adding to its worry, Chinese industrial profit − as per China’s National Bureau of Statistics − slipped by $103.8 billion in November from last year’s comparable period.
Conclusion
With OPEC’s production ceiling hike and the lift of export ban from Iran and the U.S., we can safely predict continued crude oversupply in 2016. Also, the Chinese economy in spite of stimulus measures has a long road to recovery. This adds up to another bearish market for oil going into the New Year.
As a result, upstream and integrated energy players like Chevron Corp. CVX, Exxon Mobil Corp. XOM, Royal Dutch Shell plc RDS.A and BP plc BP will continue to suffer in 2016. Year to date, their stock prices have fallen a respective 19.7%, 15.5%, 16.8% and 17.9%.
On the other hand, low oil is really good for the oil refiners like San Antonio, TX-based Valero Energy Corp. VLO − the largest independent refiner and marketer of petroleum products in the U.S. The company has shored up huge returns of more than 44% this year.
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