By Rune Likvern
Trying to predict the future trajectory of oil prices after its recent collapse has been given a lot of attention by media, allowing scores of pundits and analysts their five minutes of fame to sustain the noise and suppress the SIGNAL.
If I, with certainty, knew what the oil price would be in the near future, I certainly would not publish that in the public domain. However, looking at oil price formation and demand development, including the perspectives of total global debt (and changes to this), the interest rates and the present (low) oil price does reveal something about the supply/demand balance and expectations for its near future developments and gives some clues of what to expect.
The strong growth in the oil price from the start of this century coincided with a period of aggressive global credit/debt expansion accommodated by a decline in interest rates. The market acted as a clearing house that used price arbitrage to balance demand and supplies.
To me the big unknown for the short term (next 1 – 2 years) will continue to be: Developments to demand.
Demand will continue to be what one can pay for.
In this post (and several others) I have persistently drawn attention to the relations of the growth in total global debt and how that has “forced” interest rates down. Debt growth and low interest rates allowed also for growth in demand/consumption of oil and for some time sustained a high oil price. The high oil price stimulated the supply side to go after more costly oil to extract.
Light tight oil (LTO, shale oil) has demonstrated that it could fast ramp up production when the price justified that. LTO, because of its agility, will likely for some time play an important role as a supplier of the incremental barrel as the price allows.
The global supply potential of oil appears to be well understood with realistic short term (the next 1 – 2 years) projections. A big unknown is if all oil suppliers (net exporters) have the stamina to let the market sort things out, or if some of the suppliers will reach some understandings/agreements to accelerate this process and at some point start withholding supplies and thus provide support for a higher oil price.
The recent strong stock builds of oil (in the US) serves as an indicator that consumption still lags supplies.
Supply equals consumption plus stock changes equals demand. One important factor that allows for demand are developments in global credit/debt expansion. A collapsing oil price while interest rates are low may suggest a slowdown in global credit expansion.
The Federal Reserve (the Fed) has communicated its intention of hiking the interest rates (fed funds rate) later in 2015. This will affect the estimated $9 Trillion in dollar denominated debt and divert more of local currencies into servicing this debt. A higher interest rate from the Fed will likely strengthen the US dollar and thus increase the diversion of more local currencies towards the service of dollar denominated debt. The deployment of future monetary policies (future trajectory of total global debt and interest rates) will influence demand for oil and thus its price. A less accommodating global monetary policy will affect oil demand and cause the oil price to remain subdued until the supply/demand balance dictates otherwise.
Cause and effect of the relations between total global debt levels, interest rates and the oil price are of course subject for some well informed debates. If, for whatever reason, some of the Oil suppliers agree to withhold supplies to support a higher oil price, it will be interesting to see if and how that affects interest rate policies and total global debt levels.
This is a guest post which first appeared on Fractional Flow. To read the full post
Mr. Likvern has 20 years of experience with several international oil companies, primarily Statoil. He was involved in management, site supervision, field development, area studies, exploration economics, value chain analyses and technical and commercial responsibilities for natural gas logistics.