What is the Outlook for the Oil Price?

The central cause of the price collapse is a supply and demand imbalance. While short-term excess supply weighs on prices, we expect oil prices to settle at $90-$100

Jason Stevens 30 December, 2014 | 3:39PM
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What a difference six months makes. The collapse of oil prices has been one of the more dramatic turns of events in the energy industry in recent years, rivalling the 2008-09 collapse. While the surge of crude oil production from U.S. shale was well anticipated by markets, the return of 500,000 barrels a day of OPEC crude to export markets in August, coupled with signs of weakening demand, prompted a wholesale sell-off in crude oil. OPEC's decision over Thanksgiving to maintain existing production quotas removed the last real hope for a quick recovery, and sent prices tumbling. 

By our estimates, the crude oil market is oversupplied by about one million barrels a day (mmb/d), against a total demand of around 93 mmb/d. While demand next year looks likely to increase by roughly one mmb/d, supply is likely to increase as well, unless the price drops enough to prevent it. But most supply additions stem from projects with long lead times, and much of next year's growth is already taken into consideration. That leaves US. shale, where companies can more easily drop a rig and dial back production growth. Thus we've seen prices decline below the average industry breakeven price of around $70/bbl. Companies are beginning to respond, announcing cuts in 2015 capital spending. 

In theory, reduced capital expenditure should drive lower production growth. In practice it takes time for capex reductions to flow through to drilling activity, and even then producers tend to focus their budgets on their most productive acreage, and drive hard bargains for oilfield services, the largest component of capital spending for upstream producers.

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Jason Stevens  Jason Stevens is an associate director of equity research at Morningstar.

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