2016 Oil: What's In Store?

November 11, 2015

[This article originally appeared in our November issue of ETF Report.]

October 2015 Cover Over the past year, oil has been having a rough and ugly ride. From a peak of more than $106 a barrel last June to a trough of less than $38 this August, oil prices faced one of their worst declines in modern history in 2014 and 2015. Oil companies responded by sharply reducing their investments in new U.S. wells, but is it enough to finally stabilize the market?

ETF Report sat down with three experts to answer that question and get their insights on other key issues facing the oil market heading into 2016: Phil Flynn, an analyst at futures brokerage Price Futures Group; Michael Cohen, head of energy markets research at Barclays; and Fadel Gheit, managing director and senior analyst covering the oil and gas sector at Oppenheimer & Co.

Oil in 2016 Whats in Store

Where do you see oil prices going in 2016?
Phil Flynn: We’ll see prices rebound because you’re going to see a massive cut in capital spending that’s already started to take its toll on supplies. One of the worst things that happened is that little double dip that we had in oil prices. Prices recovered in July and they brought back all these oil rigs and everybody thought the worst was over, but then prices crashed again because of China and Europe and Iran. Now everybody’s going to be afraid to bring production back on, which means they’re probably not going to act quickly enough when prices come back up.

Low prices will stimulate demand at a time when production is cut back. I think we’ll average $57 next year, but see a spike as high as $80.

Michael Cohen: We don’t think the current price levels are sustainable for medium-term growth of supply in order to meet the demand that’s been spurred on by these lower prices. Therefore, we expect we’ll see an adjustment back up into the $60 range in the second half of next year, and that that price level is going to be required to have enough supply to meet demand.

Fadel Gheit: We expect oil price volatility to continue in a narrow range below $50.

What’s your outlook for supply? Is the recent drop in U.S. production something that’ll continue?
Flynn: It will drop by 1 million barrels per day. I think most people are behind the curve on those estimates. We’re already seeing evidence of the decline in Cushing, Oklahoma, where supplies are falling faster than anticipated.

Cohen: Over the next two to three months, we’re likely to see supply continue to decline. However, once the market realizes it needs U.S. shale output to continue to grow at a decent pace of 100,000 or 200,000 barrels a day per year, there will be a price impact later on in 2016.

Once that happens, you could get U.S. crude output back up to 9.6 million or 9.7 million barrels a day. We don’t really see a scenario in which U.S. production declines steeply, because there will be a market impact from that. Most of the U.S. producers that are sitting on a backlog of wells that they want to complete and bring on will do so at higher prices. By doing that, they’ll support overall output and mitigate the decline from existing fields, and there won’t be a steep trajectory down.

Gheit: We expect flat to small declines in supply as capital-expenditure cuts will be largely offset by efficiency gains and better allocation of capital. Production from new major project startups will offset shale production declines.

Demand is growing faster this year thanks to lower prices, but will the slowdown in China and emerging markets derail that next year?
Flynn: China definitely is slowing, but we haven’t really seen that in its energy demand as of yet. The stimulative actions by the government will provide support to demand, and it could surprise to the upside.

Cohen: If China grows much slower than the 5 to 7% the market expects, that could have ramifications for other Asian economies and other economies that trade with China. That’s the kind of scenario in which we could see another dip in prices below where we are even right now. That’s not part of our base case, but it’s a possibility.

Gheit: Demand growth is expected to remain anemic because of slower economic growth and conservation.

Do you see geopolitical risks from these low oil prices?
Flynn: The biggest risk is the Syrian war spreading. This thing could get out of control; it really could.

Cohen: Certain countries are able to weather these prices. Russia and Saudi Arabia are some of those that fall on the spectrum of being best prepared for this kind of environment. Then there are other countries on the complete other side of the spectrum—like Libya, Nigeria, Iraq—that are much worse prepared for a lower-for-longer price environment.

Gheit: Eventually, oil exporting countries will have to get used to the low oil price, as it’s likely to be the new normal. They have to live within their means, diversify their economies to be less dependent on oil export revenues, and gradually reduce fuel subsidies.

Anything else you’d like to add?
Flynn: The downside risk for prices is if the global economy really falls apart next year. It’s obvious the Fed is concerned about the lack of inflation, so it will likely err on the side of being more accommodative, which is supportive for prices.

Cohen: The market is struggling now, trying to understand how much incremental oil Iran can sell to the market when it begins to export again. The forward curve and the price of oil reflect that Iran will likely add around 500,000 to 700,000 barrels a day from current levels to the market. If we see a slip in when implementation of the Joint Comprehensive Plan of Action [nuclear deal] occurs, then the market would likely have to readjust the assumptions about incremental exports from Iran.

Gheit: Continued low oil prices are likely to lead to industry consolidation, resulting in bigger and much stronger companies both operationally and financially that are more resilient to low oil prices.

Oil in 2016

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