The oil price, as measured using the Brent benchmark, continued to slide early this week, hitting a new six-year low of $45 a barrel. It has now plunged by 18% this year and 60% in just six months. Analysts – virtually all of whom failed to predict the trend – have been racing to cut their price forecasts as a result.
Investment bank Goldman Sachs cut its forecast for the average price in the second quarter of 2015 from $80 a barrel to $42. The latest slump was partly due to a statement from oil cartel Opec.
It insisted that it would not cut production. It is hoping to force many US shale drillers – a key source of new supply – out of business in order to protect its market share. Traders have begun to place bets on oil falling as far as $20 a barrel.
What the commentators said
Goldman, which was caught on the hop by the credit-crunch-induced oil plunge in 2009 – just after it had predicted $200 oil – is probably right to suggest that “prices need to stay lower for longer”.
To find a floor, said Bank of America Merrill Lynch, the market needs one of three things: Opec output cuts, non-Opec supply cuts, or higher global demand.
The latter can’t be expected to materialise for some time – price falls take around six months to filter through and influence the world’s appetite for oil. Opec won’t be cutting for the foreseeable future. That leaves non-Opec producers.
On this front, there has been a lot of talk of drilling becoming uneconomical at around $60 a barrel. But exploration and drilling cost aren’t the key issue for output, said Edward Hadas on breakingviews.com. The drilling is the pricey bit, but however much that costs, a well owner will keep producing oil from a well until it costs less to close down than to run.
This “operating break-even price is typically very low and frantic cost cuts will reduce it further”. The upshot is that only a small part of overall production will become uneconomical until the price is below $30.
So while drilling is beginning to slow – the number of US rigs fell by 5% in the month to early January – production won’t follow before prices have fallen further. Indeed, this week the US Energy Information Administration forecast an increase in American production next year. The oil-price floor, concluded Hadas, “could be a long way down”.