Sunday Times

$50 a barrel is right on time, says oil guru

- MATTHEW PHILIPS

BEFORE the first week of the year was over, the oil price had dropped 9%.

Oil prices fell below $50 a barrel on Monday for the first time since April 2009. By Tuesday, oil traded below $48.

It wasn’t that long ago that analysts were gasping at the prospect of $70 oil, a threshold oil moguls and petrostate­s will be relieved to be anywhere near by year-end. A lot of well-paid people saw $60 as a likely floor.

But that was three weeks and $12 ago.

I was in Houston the day oil first fell below $60, at a Chamber of Commerce lunch heralding the strength of the local economy — 40% of which is based on oil. Despite the Texas-size grins, you could sense the panic starting to creep in.

Talk to a commodity analyst these days, and you’ll probably hear about the “commodity super-cycle”, a wonky term to describe the way supply and demand for such things as oil and copper move in a slow, decadeslon­g dance that eventually repeats itself. As supply moves from periods of scarcity to surplus, prices rise, fall, and then rise again, killing demand before fuelling more of it along the way.

Jeff Currie, head of commodity research at Goldman Sachs, pays particular attention to this interplay. He said that over the past century, the average length of an oil supply cycle was about 25 to 30 years. That put the current sell-off right on time, considerin­g it’s coming almost exactly 29 years after the oil bust of 1985-86. Both sell-offs are the result of too much supply. In the 1980s, it was the Saudis who flooded the market. This time round it’s frackers in the US pouring millions of new barrels onto the market.

Oil prices crashed in a similar fashion in 2008, but for a different reason. After several years of rising prices, oil got so expensive that demand dropped. As the global economy crashed, oil fell from $148 a barrel to $40 during the last half of 2008. Throughout that sell-off, however, the futures market stayed optimistic. Oil contracts four, five and six months into the future remained relatively high, meaning oil speculator­s always thought prices would soon rise, which they did.

“You really didn’t have much of a chance to trade that market back then,” said Currie.

This time, the futures market has tanked along with current prices. A barrel of oil for delivery in July is only a few dollars more expensive than it is right now, meaning oil speculator­s think low prices are here to stay. If prices come back more quickly than expected, a lot of money can be made.

The market has reached what Currie called the “exploitati­on phase” of the oil cycle, when years of investment­s fuelled by high prices have unlocked a long-term supply. This is essentiall­y the reward. After the crash in the mid-1980s, oil prices stayed low for more than a decade, helping to fuel a sustained period of economic growth. With any luck, the same will happen this time.

But with lower prices come lower investment­s, which will ultimately lead to fears of shortages and higher prices and the start of another commodity cy- cle. For now, though, the entire oil industry is getting repriced downward. “We’re moving down the cost curve and eating away at the fat that’s developed in the system,” said Currie.

By fat, he means the roughly $90-billion (about R1-trillion) in debt issued by junk-rated energy companies over the past three years. Drilling for shale oil in the US is an expensive endeavour. A horizontal­ly fracked well produces most of its oil and gas within about 18 months, so companies need to drill faster and faster just to keep pace. Many of them were spending more than they were bringing in. It was only a matter of time before that caught up with them, particular­ly considerin­g how high the yields were on their debt.

“High yields are the markets telling the world to quit using capital in this way,” said Currie. Now that capital will search for a new, safer home. — Bloomberg

Oil prices then stayed low for more than a decade, helping to fuel economic growth

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