The case for $20 crude oil

Financial Mirror (Cyprus) - - FRONT PAGE -

Oil prices have dropped to $35 a bar­rel, down from over $110 in 2011. The trend line does not mean much; it is just a chart. But that does not mean the causes of the trend are not ob­vi­ous, and likely are also not over.

The ar­gu­ment for lower oil prices breaks into a very few parts. The first is that mas­sive oil pro­ducer Saudi Ara­bia means to de­stroy the in­dus­try fi­nan­cially so that it can keep its long-term lever­age on pric­ing. Its pro­duc­tion costs are low enough that its strat­egy might work. But even Saudi Ara­bia can­not pump cheap oil for­ever with­out af­fect­ing the king­dom’s trea­sury, and per­haps crip­pling it for decades.

An­other cause is frack­ing, an in­dus­try that bet high oil prices would last for years or even decades. It is an ex­pen­sive busi­ness to get into, with some­what new age tech­nol­ogy, so frack­ers need prices well above the cur­rent ones to re­main is busi­ness. Sup­ply is am­ple. Fund­ing is not. Bank­rupt­cies are not only pos­si­ble, but they al­ready have be­gun.

An­a­lysts from Bloomberg re­cently wrote: “Ac­cord­ing to the con­sul­tancy Wood Macken­zie, about a third of oil pro­duc­tion in the U.S. states, not in­clud­ing Alaska and Hawaii, comes from com­pa­nies that have bor­rowed against their oil and gas re­serves and that face re­de­ter­mi­na­tions of their bor­row­ing base. Banks re­cal­cu­late the value of re­serves for their oil com­pany clients twice a year, in the spring and in the fall. Fore­casts for the Oc­to­ber re­de­ter­mi­na­tions are dire. Last month, a sur­vey con­ducted by the law firm Haynes and Boone pre­dicted a 39% de­crease in the oil com­pa­nies’ bor­row­ing abil­ity, with 79% of bor­row­ers ex­pect­ing a de­crease.” For fi­nanciers, bet­ter to take a beat­ing now than a worse one later.

Fi­nally, there is the the­ory that China’s econ­omy has slowed. As the world’s largest im­porter of oil, it makes sense that the de­mand loss would take a bite out of the price of crude. On the other hand, the economies of the United States and Europe are re­cov­er­ing. The anal­y­sis has be­come a tightrope of ex­pert fore­casts.

Is past per­for­mance an in­di­ca­tion of fu­ture re­sults? No, as mu­tual funds would say. How­ever, for oil prices that an­swer may be dif­fer­ent.

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