Oil has suffered one the most severe price declines in recent memory, dropping over 60% in the past year. West Texas Intermediate (WTI) futures are currently trading at $49.14, after touching a low of $42.03 in March.
An analysis of WTI’s long-term fundamentals, the world’s geopolitical environment, together with short-term sentiment and technical indicators, gives me reason to believe that the price for WTI, might have some upside potential in the coming weeks. In the following paragraphs I will explain these factors in more detail.
The current oil price is unsustainable
The most important catalyst for oil’s stunning decline was the enormous amount of new supply brought by US Shale oil companies. As a result of the “US Shale revolution”, oil production in the United States has surged to highest level in over 45 years (Figure 1).
Figure 1: US oil production (Source: EIA)
Notwithstanding, the price of oil needs to be significantly higher for the US to maintain its high level of production. Several analyses by Deutsche Bank (Figure 2) and Citigroup (Figure 3) indicate that the current price of oil is well below the long-term breakeven prices required by the majority of shale oil producers.
Figure 2: Growth in US production is subdued if oil stay’s under $70 (Source: Deutsche Bank)
Figure 3: US shale producers need an oil price around $60 to stay afloat (Source: Citigroup)
Although US oil production is still rising, the current low price environment will undeniably have a sizable impact. An analysis conducted by Deutsche Bank, indicates that US oil production could peak in May 2015, followed by a subsequent decline in the second half of 2015 (Figure 4). It is worth noting that the model employed by Deutsche Bank incorporates drill rig efficiency gains.
Figure 4: US non-conventional oil production and rig count model (Source: Deutsche Bank)
A peak in US shale oil production would signify a major turn in the energy market, which provides oil prices with a bullish fundamental backdrop.
The world is a geopolitical mess
The abundant presence of US shale oil, has also served to mask the frightening geopolitical environment engulfing many of the world’s largest oil producers (Figure 5). The significant decrease in political stability in regions such as the Middle East, Venezuela, Nigeria and Russia are potentially significant long-term bullish catalysts for oil prices.
The Middle East
Yemen is the latest Middle Eastern country to descend into a state of utter chaos. As of March 25th, Saudi Arabia has commenced “Operation Decisive Storm”, a large military offensive directed against the Houthi rebels in Yemen. The current military campaign in conjunction with other Sunni Arab states including the UAE, Kuwait, Qatar, Jordan, Bahrain and Egypt is one of the largest military operations ever conducted by an Arab coalition. Over 100 fighter jets, 150,000 soldiers, and several naval units are dedicated to the effort.
Although Yemen, is not a significant oil and gas producer, the recent escalation can have significant repercussions. Obviously, this conflict will further inflame sectarian tensions across the region. Secondly, the current power vacuum and poverty present in Yemen, creates the perfect breathing ground for terrorist groups such as Al Qaeda. To top it off Iraq, Syria, and Libya are currently ravaged by active fighting with no end in sight. On the long-term, these factors increase the risk of supply disruptions and/or terrorist attacks on energy infrastructure in the region.
The socialist republic of Venezuela is on the brink of a total economic collapse. According to a recent article by Quartz, Venezuela is the world’s worst performing economy. The country is facing a currency collapse, roaring inflation of nearly 70% per year and a deep economic recession. Worst of all Venezuela’s government finances are in tatters and a Sovereign default seems unavoidable.
According to sources cited by Citigroup research, there are active rumors and talks about a coup against President Nicolás Maduro. Venezuela is a major oil producer and has the largest proven oil reserve base on the planet. A violent regime transition could jeopardize oil drilling and export activities.