In an editorial this week, acclaimed oil market expert Gary Shilling stood by a prediction he made in August 2015 that oil prices would collapse to $10 per barrel citing higher than expected North American fracking outputs and OPEC’s refusal to limit production.
This February, the oil market analyst’s prediction seemed prescient as the world’s energy industry faced the single greatest market collapse in history with oil prices coming off a 2008 high of $147.27 down to a measly $26 per barrel. At the time, Saudi Arabia moved to increased oil production by 1 million barrels of oil per day to 10.5 million barrels with the Crown Prince demanding that the country’s output increase to 12.5 million barrels daily by 2017.
The world currently produces just shy of 100 million barrels of oil per day and market analysts calculate that for every 1%, or 1 million barrels per oil, that supply exceeds demand oil prices fall by 25%.
At the time of the market collapse, it was estimated that the market was over saturated by several million barrels per oil and continues to be pounded by Saudi overproduction.
Shilling’s argument is a harbinger of danger to come for oil dependent economies such as Venezuela, Libya, and Algeria who lack the access to capital markets necessary to weather a collapse in their oil sector with policy experts fretting that these countries could fall into permanent disarray if the analyst’s argument holds true.
The raw mathematics of Shilling’s argument are most perturbing as he points to the wildfires in the oil-sands in Canada, output cuts due to political unrest in Nigeria and Venezuela, and speculation that the non-state sponsored American hydraulic fracturing industry would go belly up before the market rebounds.
Accounting for the excess supply slack once geopolitical chasms quell and as Canada recovers from the massive Fort McMurray fire that scorched Alberta’s energy industry, easily an extra 4 million barrels of oil could come on line within the next few months savaging the industry.
This also comes at a time when Iran has moved to increase their oil output in a market share arms race with their regional adversary Saudi Arabia who increased production with reckless abandon despite driving prices well below their own breakeven price in a bid to bankrupt oil companies and entire energy dependent countries.
Fortunately, there is a major flaw in Shilling’s assessment which assumes that geopolitical factors that influence production remain constant despite a rout on oil prices. Notably, the instability of smaller, less diversified oil producing countries like Venezuela and Algeria would come to an immediate halt as would, presumably, their entire governing apparatus bereft of the necessary funds to administer the state.
Oil investors know that in addition to breakeven points, all of which have been clearly trounced in the energy market collapse, there is a breakdown point – an oil price level that causes so much economic destruction that the shock itself implies that the market valuation of the natural resource would immediately rebound.
Knowing that a $10 oil price would mean the creation of an immediate oil shortage of over 10% per day that would send the market skyrocketing on bounce back over $100 per barrel, investors price the middle point between the two extremes.
No, a collapse to $10 per barrel is not likely or even particularly possible regardless of how much Gary Shilling decides to short the market and put out opinion pieces to try to recoup some of the losses on his foolish market bet.
