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Oil Prices See A Bottom As Oil Supply Shrinks

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By Johnny Bevers

After OPEC announced its intention to not reduce its production for fear of losing market share, oil prices plummeted to record lows across the globe.  In it’s most recent report for the week ending December 19,2014, the US Energy Information Administration (EIA) reported an 800,000 barrel decline in American oil stock piles which sent signals across the equity markets that we may have reached the bottom price in the declining oil market.

Oil traded below $55 a barrel last week and closed out the week at just over $57/barrel on Friday.  As oil trended back up late in the week, equities also began to climb, sending very strong signals throughout the energy markets that we may finally be at a bottom with respect to price.

Shows historical oil prices from 1 Jan to 26 December 2014

Courtesy Of NASDAQ

This can be seen in rising share prices of the major energy players throughout the United States and abroad.  Companies like Exxon Mobile were experiencing lows in the $86 dollar range and later managed to close at $93.64 on December 19, 2014.  This move alone is a very strong indicator that most price speculators are seeing much less supply in the global oil market, and are now bidding a little higher since we seem to be drawing toward the end of the supposed oil glut.

My take is simply that oil producers will not sell their reserves when the price of oil is this cheap on the market.  Many of them will satisfy their futures contracts at much higher prices; however, they will be hesitant to let go of their proven reserves at such low prices.  We can see many companies shrinking their CAPEX budgets for 2015 because the break even points just aren’t being met.  In addition, a number of countries around the globe will reduce their output to only deliver on their previously negotiated contracts.  That said, I’d expect a continued decline in oil supply and an increasing price as we head into early 2015.

OPEC logo on location

OPEC Logo Courtesy of Reuters

Now, there’s much to do about OPEC’s market share.  The truth is, OPEC only controls about one third of the world’s oil supply.  While that sounds like a lot, it’s very easy for other countries to simply reduce output until they can get a price that makes sense to them.  Many need to see oil above $90/barrel to stabilize their currencies and balance their budgets.  Russia is a perfect example of this phenomenon and their country has seen the ruble shrink to record lows along with the price of oil.  The fact is, all they really have to do is lower their output by a million barrels a day (from the seven million they currently produce.)  This alone would stabilize oil around the globe.  I say this because the world is producing around two million barrels a day more than it really needs.  Countries are already reducing their output and if Russia announced they were producing one million barrels less per day, we’d see a sharp increase in the price of oil.  It’s very simple supply and demand economics and no one is in a better position than Russia to take supply off the market.  The United States has too many independent operators, but most US energy companies are now not drilling at these price levels and oilfield workers have been laid off across the country.  This reduction in American CAPEX will sharply reduce supply which will tighten the oil markets.

My prediction is that energy companies and the larger non-OPEC countries will probably over react and drastically cut their production.  They probably already have; however, the data hasn’t come in “yet” to support those flashing red signals.  In the months to come, you’ll see oil back in the $80-$90 range and maybe higher as our largest oil producing activities slow their production effort.  When?  I’m guessing we’ll see a gradual increase between now and mid Summer of 2015 where oil will begin to stabilize over $80/barrel.

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