Three possible scenarios for oil prices in 2015

With oil prices having dropped by more than 45 percent in the space of five months, this global commodity is doing more to capital markets and investors than war ever did.

For the first time, western investors are calling on the Organisation of the Petroleum Exporting Countries (OPEC) to interfere in the so called freedom of the market, while the oil-producing bloc insists on allowing prices to fluctuate according to the laws of supply and demand.

For the first time, western investors are calling on OPEC to interfere in the so called freedom of the market.

Despite criticism of OPEC’s decision in Vienna on 27 November to take a laissez faire approach to low oil prices, by not reducing the production ceiling of 30 million barrels a day, oil market analysts believe it fully complies with the organisation’s interests to maintain its share in the global oil market. This is based on the principle of capital, which allows prices to float freely. The estimated annual market is worth $3.4 trillion, and speculation in future markets worth more than $10 trillion.

The question is, how long will the price drop last? Will oil from external producers decline to allow the available oil supply to be absorbed and hence gradually increase the prices?

The price drop

At first sight, the rapid drop in oil prices might seem confusing, but take a closer look and there are logical reasons for the decline. First, during the second half of last year, there were frequent predictions made by the International Monetary Fund (IMF), among others, about slow global economic growth in 2014. Thus, the International Energy Agency (IEA) and OPEC reviewed the expected levels of global oil demand, which created some activity among oil investors and speculators.

Second, there have been huge investments in the oil industry by many states and companies over the past four years when prices were high. According to Barclays Capital, these investments reached close to $2.4 trillion creating a surplus of almost two million barrels a day.

Third, speculation that further unrest in geopolitical flashpoints in oil producing countries such as Iraq, Libya and Nigeria would lead to higher oil prices, did not materialise. The revolutionary breakthroughs in the production of shale oil contributed a further 4 million barrels a day on the market from US production capacity, which covered all oil shortfalls in the unrest.

Future scenarios

Energy experts have suggested three possible scenarios for oil prices in 2015.

The first scenario is a pessimistic view that oil prices will continue to decline until they reach around $40 a barrel in the first half of 2015, increasing gradually in the second half.

This prediction has been mooted by countries like Iran who stand to be the biggest losers if oil prices drop further. However, this is also an unlikely development as global oil demand is likely to be strong especially as the world’s two largest economies, the US and China, are expected to grow by more than 3 percent and 7.5 percent respectively in the coming year. In addition, the surplus in the oil market is not significant with current estimates ranging from 700,000 to 2,000,000 barrels.

The second is scenario is more optimistic, that oil prices, with $60 a barrel Brent crude reference price, is the lowest that we will see. There is a belief that oil prices will start to fluctuate around that level for the first quarter of 2015, reaching up to $70 until the end of the second quarter, and around $75 during the second half of the year.

These are the prices predicted by the US-based Bank of America Merrill Lynch. Alberto Ades, head of Global Emerging Markets Fixed-Income Strategy and co-head of Global Economics, told al-Araby al-Jadeed that oil prices could reach $80 a barrel in 2015. However, prices are not likely to reach their previous levels before June.

Investors have started to pull out of the oil industry, especially from US shale oil firms

The most likely scenario is that prices will return to $90 a barrel by the end of the second half of 2015. Francisco Blanch, head of Global Commodity Research at Bank of America Merrill Lynch, believes that the oil market will be able to absorb the surplus, bringing prices back to $90.

Investors panic

It should be taken into account that the drop in oil prices, from $115 in June to less than $60 on 16 June for Brent crude oil, came about mainly due to concerns from oil investors. Market trade is governed by panic more than the rules of supply and demand or market powers. Investors have started to pull out of the oil industry, especially from US shale oil firms that appear to be on the edge of collapse due to low oil prices.

Share prices continue to drop rapidly, increasing panic among oil traders and investors, especially when 10 major oil companies lose $75 billion in market value in only three days, and an oil billionaire loses nearly $10 billion, half of his fortune, in just a few months.

And so this huge drop in oil prices does not match the levels of supply, demand and surplus in the market. It was mainly caused by panic with investors racing to minimise the expected damage that is caused by irrational sales, whether in future oil markets or on Wall Street. This is why oil shares were the first to fall.

Even worse, oil companies carry significant weight in the main indicators of the US market. They constituted nearly 7.18 percent of the Dow Jones Index, the capital value of which reached nearly $24.82 trillion by the end of November. They also constitute 9.43 percent of Standard and Poor’s index, valued at $2.012 trillion. These are the two main indices of the capital market in the US.

Therefore, with traders escaping oil shares and investors escaping future oil deals, there was a state of panic, which led to a large decline in the indices of the US capital market. Usually, US indices measure the decline of global shares. They have shown that capital markets around the world have lost around $1.2 trillion last week.

Concerns in the Gulf

As for the losses in the Gulf stock markets, the main reason behind their sharp decline was investors' fears that these governments would cut spending in 2015. Contracts for new public infrastructure projects are one of the main motivators for private companies operating in the Gulf. Oil companies do not have a significant weight in the Gulf capital markets, the capital value of which is an estimated $1 trillion, so a 45 percent drop in oil prices in only five months is generally the result of panic rather than a failure of the market.

In terms of supply, Standard and Poor’s believes that 80 percent of the 170 US oil companies will face financial challenges next year. This will lead to a decline in the production of shale oil.

On the other hand, Professor Leonard Maugeri from Harvard University believes that the revolutionary US oil production will continue for some time despite the current price drop.

Maugeri says that some shale oil fields in McKinsey County, North Dakota and the Bakken and Three Forks formations, produce nearly 350,000 barrels a day, and can continue their production at this rate with low oil prices. At crude oil wells in west Texas, production does not cost more than $28 a barrel.

However, Professor Maugeri noted that the cost of production for 80 percent of the other shale oil fields exceeds $42 a barrel, while 20 percent cost more than $85 a barrel. These are low-cost oil fields, which means that shale oil production in the US may decline in 2015 and the companies operating fields may well face financial difficulties in the coming year that will make other countries think twice about ramping up oil production.

This article is an edited translation from our Arabic edition.