Following the post-COVID stimulus hangover in 2022, the bull market has continued to run. One of the key factors was the Federal Reserve’s decision to
How Low Can Oil Go?
Published Date : February 10, 2015
Oil finished 2014 down a massive 46% – making it the worst performing asset class of 2014. In The Wall Street Journal’s January 2014 economic forecasting survey, economists predicted oil would finish the year at approximately $95 a barrel, up from about $92 at the beginning of the year. But – as we saw very clearly– economists can be wrong. Crude prices not only nearly halved by year-end, the selling didn’t stop then. Investors headed into 2015 with prices dipping below $50 a barrel and hitting 5-year historic lows.
The enormous and unexpected decline in prices is due to a perfect storm of factors. On the supply side, advancements in technology led North America to become the largest producer of oil, resulting in the strongest non-OPEC supply in over 30 years. While America doesn’t export, it now imports much less, creating a glut of extra supply globally. In November, OPEC also announced they plan to maintain current production despite falling prices – a decision not seen since 1986. In addition, geopolitical risk decreased significantly as turmoil in two big oil producers (Iraq and Libya) did not affect their output. On the demand side, we saw the second lowest Chinese oil consumption since 1990, the warmest weather on record across Europe, and huge negative demand revisions in Russia, Ukraine, Syria, Iraq and Japan. The result was a colossal crash in the price of crude.
The question everyone is asking is: how low can oil go? One important metric is the breakeven cost of production. While this point varies widely from basin to basin and project to project, the general consensus seems to be that the average lies in the $50-70 range, leading some to believe we’re close to a floor. Perhaps a more relevant breakeven point is that at which OPEC nations are able to balance their national budgets from income and taxes. According to the Economist, all OPEC nations require oil above $70 to be able to do so, but some have the ability to endure lower prices for a period of time thanks to copious cash reserves. While Saudi Arabia can tolerate cheap oil for quite some time, eventually they require oil above $90 to stop draining their reserves. Taking another tack, if we look to history as a guide, the black gold briefly dropped below $40 a barrel during the 2008 financial crisis before it began its ascent.
All this is to say that the answer is one that no one wants to hear: it is truly impossible to know how low oil can go and how long low prices can be sustained. What we do believe is that current levels cannot persist over the medium to long-term and now represent an excellent buying opportunity for long-term investors able to withstand potential future volatility in prices. At Sand Hill, we seek to be long-term and contrarian, taking advantage of opportunities such as this to add value for our clients over time.
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