The Crude Awakening

A year ago Brent Crude was having a great time. The price was around $110 a barrel, the surplus was down, and, importantly, the demand was high. The distant days of the Deepwater Horizon saga were behind us. Everything was good…

Fast-forward a year, and things have changed dramatically. The Brent bubble has burst, and we’re having to deal with the reality of low oil prices which are likely to be around for a long time.

Goldman and Citi have both revised down their forecasts for the year, and Morgan Stanley have gone on the record to say that prices of $20 are not just realistic, they are highly likely.

So, in short, what the heck is happening?

The strong dollar is partly to blame for the crude crisis, after all that’s what the commodity is priced in, but there are other factors at work here causing the price to plummet.

Twenty Bucks’ll Getcha a Barrel

If you’d have said a year ago that we’d be looking at historic low prices for crude, you’d be laughed out of the room. But now, a year on from the dizzy heights of $110 a barrel, we’re experiencing 12-year lows and the latest is that the price could fall a whole lot more.

And $20 a barrel is a significant figure. It’s the figure that has been calculated to be the breakeven point for highly levered high-cost US shale producers. If oil prices dip even a cent lower than that, producers will have to cut output or operate at a loss. And they are already operating on an unfair playing field. As we reported in one of our alerts (14th October 2014), the cost for each country to get a barrel of oil out of the ground is significantly different, with the Saudi’s paying below $10.

The strong dollar is partly to blame for the crude crisis, after all that’s what the commodity is priced in, but there are other factors at work here causing the price to plummet.

The Middle East v China

It’s all kicking off in the Middle East again, with tensions rising between key OPEC members Saudi Arabia and Iran. Saudi Arabia have recently executed a significant Iranian cleric, which, in short, has caused the current conflict between the two nations. Diplomats have been asked to leave Tehran, the Saudi embassy has been attacked and the situation shows no sign of dying down.

This situation would normally be enough to kick-start the oil markets. Production fears are always good for the Bulls, but this ‘situation’ in the Middle East comes at an interesting time.

As mentioned before, the dollar is growing in strength on the global stage (and oil is priced in USD). Meanwhile, the economic slowdown and market slide in China is causing worries about the state of the Asian economy.

China is desperately injecting cash into the markets to buoy them up, after a massive crash on the first day of trading this year. Little seems to be able to lift the markets, which is causing even more concern as China runs out of alternative measures.

But the biggest factor in the fall in oil prices, has to be the fact that sanctions were lifted on Iran. This has meant that they are able to bring oil to market, and in response the price has fallen. We’re now around the $28 a barrel, with fears that it could drop further off the back of Iran’s ability to add half a million barrels a day to the already huge supply glut.

This oil price is also enough to throw the Saudi Arabian economy into problems, with £27billion wiped off the value of the Middle Eastern stock markets in response to Iran being able to enter the oil markets.

So, in short, everything that should lift the oil markets has an opposing force in play, which is helping to keep the price low. And it’s not just oil that’s suffering…

Low Gasoline, and Low Gas…

Low oil prices hit other markets hard, and one of the first to suffer is the Natural Gas market. Gas has caused its own issues, but even so the plentiful and cheap alternative of oil (for heating and electricity production) means that gas is going to tank.

Natural Gas had a tough year in 2015. The US active weekly natural gas rig count fell by 166 rigs in 2015, as compared to 2014. This suggests that US natural gas drilling activity fell by a whopping 50% in 2015. And 2016 isn’t looking good either, with unseasonal warm weather and low oil prices, pulling on the commodity.

But you’d kinda assume that the energy sector would be rocked. However, one victim of the low prices is less obvious… cotton.

Cottoning On to Low Prices…

Oil is the basic ingredient in a multitude of synthetic fabric. Polyester, nylon, lycra, they all have their basis in the black stuff. So, when the price of oil is low, these alternative materials become more appealing and cost effective, especially in these times of fast fashion.

Subsequently the price of cotton is going to be rocked. Had cotton not shot itself in the foot by amassing huge stockpiles, then maybe the situation wouldn’t be so bad. But now we have the problem of low oil prices, high cotton inventories and low cotton demand, which all combine to spell disaster for the cotton markets.

Where Do We Go From Here…?

Sure, there is a lot more at play here that we can elaborate on without writing a blog that would be out of date by the time you got to the end of it. But for now, we can expect oil to stay low and push lower off the back of the sudden supply of Iranian oil flooding the already saturated markets.

For the consumer, welcome to the world of $1 a gallon gas, cheap synthetic clothes and shoes, and affordable heating and electricity. But for the oil industry, welcome to 2016, you’re going to remember this one for all the wrong reasons…

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