A crude response: great oil price correction coming soon

The drop in crude prices has market watchers expecting a price readjustment in the near future

February 6, 2015

For months, oil watchers have seen the steady decline of prices. They’ve now hit a record-making seven month consecutive low. Now given these dismal prospects, is there any hope for a Brent benchmark bump-up? World Finance speaks to oil markets expert Gaurav Sharma to find out.

World Finance: Gaurav: it’s a big question on everybody’s mind. Are we going to see a bottoming-out of prices?
Gaurav Sharma: Interesting times! I would compare it to, sort of a skating ring analogy. We have a lot of to-and-fro. We’ll see the oil price fall further; it could fall below $40. Then we have a stabilising in the range that we are: somewhere between $40-55.

This situation will last probably up until the summer. Then what I see from thereon is a surplus correction kick-in.

World Finance: How low are we really going to go?
Gaurav Sharma: The way I see it, we could go as low as $35. Now, what’s happening at the present moment in time is, we have the three major producers: the US, Saudi Arabia, and Russia, all collectively pooling up to somewhere in the region of 30 million barrels a day; in excess of 30 million barrels a day.

Right now everybody thinks that we’re just awash with oil; which is pretty much close to the truth

Here we are! We have this supply glut, and the way I see it is, it is driving prices down; but this cannot be sustained. This cannot be sustained in the long-run.

World Finance: So who’s going to prompt this change among the big players?
Gaurav Sharma: I think it’s going to be the Russians. Because the Russians are suffering from a double-blow. They’re suffering because of the sanctions; then the oil prices are going down. And of course the sanctions have resulted in a lot of their international oil and gas partners – the likes of Exxon Mobil, Shell, and so on – from sharing their technical know-how.

Now, if you take all these three factors into account, I doubt that Russian production can be sustained above 10 million barrels per day.

World Finance: Let’s talk about some of the over-arching macro-economic realities that we face right now. Christine Lagarde, head of the IMF, is warning about a drawback on investments as well as consumption; first, can you tell me if oil prices are responding quickly enough?
Gaurav Sharma: I would say, with near 70 percent certainty, that the oil prices are currently ahead of the curve.

It is a big, big bonus. Now, you cite the IMF chief, and I would say that the IMF itself, and the World Bank, and the OECD, and several independent analysis organisations, have observed that if you look at the positive effect of declining oil prices, it could add up to 0.5-1 percent of GDP. Especially to some of the emerging markets, who are heavily reliant on oil and gas to power their economies.

It’s disputed: everybody comes up with a different percentage. And you know, data is always… the projections are forward-facing, but the reality’s always looking backwards.

World Finance: Given this reality, what then does it do to commodity prices?
Gaurav Sharma: The way that I see it is, if we go back to the pre-financial crisis years, you looked at a basket of commodities, and they were always to the up-side. Then of course we had this financial tsunami in 2008-09; the whole basket of commodities, oil included, nose-dived.

Then we had a very interesting event. We had the Chinese give their own economy a massive, massive, $400bn stimulus. What happened that time was that the whole thing got flagged up again. We had again, a sort of mini-bubble.

This correction should have happened five years ago, but it didn’t. And again, the sort of leading voices were out there, calling it, ‘Oh yes, see here, it’s the commodities super-cycle.’ I’m very sceptical about that term; why can’t we just call it an ordinary cycle?

World Finance: So oil of course is only one of many indicators on commodities; so why are we hearing forecasters weighing so heavily on the impact of the slump in the market? It’s sort of a misnomer, wouldn’t you say?
Gaurav Sharma: I would say so; because another thing is, oil gives a lot of market commentators the pretext to, sort of, appear to be a little bit more shocked than they ought to be.

World Finance: Let’s talk about it, I mean… oil market watchers get paid to talk about…
Gaurav Sharma: Haha! Absolutely.

World Finance: …how important their industry is in the larger scheme of things. And yes of course, it drives markets forward. But when there is this over-emphasis, what sort of implication does that have? Don’t you think it sort of, misleads the public, in many ways?
Gaurav Sharma:
Absolutely. We talk about all the upheavals in the oil market, but I can tell you for a fact: oil is one of the easiest commodities that you can trade on the market. You only need to fork up a price of about 10 percent of a barrel. You can buy as few as a thousand barrels. Let’s say, at today’s prices you could probably put a bet in at about $500!

World Finance: The million-dollar question, Gaurav, let’s leave you with this. Will the price fluctuation that we’ve been seeing in the oil markets make for a more bullish or bearish 2015?
Gaurav Sharma: I am still overwhelmingly bearish. I would still say we will sort of have this fluctuation between $35 and $55 as far as oil is concerned, all the way up to June.

As I said earlier, I do not see the current levels of production being sustained. And that will definitely have a bearing. We will see some of these projects… I mean, if you look at some of the independent upstarts in the US. You look at some of the Russian projects. You look at the Arctic. You look at Brazilian deepwater.

Some of these projects were not event profitable at $100 a barrel! Now if these projects could not be sustained, even at $100, how do you think it’s going to be sustained at $50?

So there will be a correction. We will see some of these projects being put on hold, some of them being financed at a massive premium… all of this will be, sort of, price positive, as far as the direction of the oil price goes, because it will create the perception that less oil is coming out of the market. Which isn’t the case right now.

Right now everybody thinks that we’re just awash with oil; which is pretty much close to the truth.