SECOND HALF VIEW ON OIL

Oil price has been hovering between the range of US$55 - US65 per barrel for the greater part of this year. But what will the second half hold?  Let us look at some known factors that could influence the oil price positively.

1) Iran's parliament just voted against giving the UN inspectors access to their military sites. This in effect will delay the lifting of sanctions by the international community against Iran. So in the short to medium term, Iran will unlikely to export more than permitted by the existing sanctions.

2) The ongoing crisis in the Middle East. Limited to Yemen, Syria and Iraq currently, but could deepen, as Saudi Arabia opposes the new Yemeni Government while Iran supports it.

3) Most of the US shale oil producers managed to survive the oil crash through hedging, but as the hedges run dry, they will face greater difficulty in generating the required cash flow to service their heavy debts. To begin with, many were already operating with negative cash flow in the first place and rely on debts to finance their continuous drilling. This could put many at risk of bankruptcy.

4)  In a Bloomberg article, it was reported that many shale oil producers used their huge untapped reserves to draw investors and lenders. A big portion of this reserves will be written off if oil price still hovers in the US$55 - US$65 because they are not profitable to be brought to production at this price range. This will affect the companies' balance sheet and damage their capacity to continue to tap into the debt market. Which lender would want to lend to a company with declining assets? Without additional capital, the potential for bankruptcy increases. Some have opted to selling shares but fund raising through placement of new shares will do little to staunch the steady bleed of cash.

5) Production from the most prolific shale regions are showing signs of slowing down.

6) US oil rigs count has fallen more than 60% since peaking in October 2014. This could impact the future production of oil negatively in the US

7) The oil crash has caused as much as US$200 billion worth of investment being deferred globally and caused more than 100,000 jobs being lost. With 1 new barrel of oil being discovered for every 2 barrels consumed, continued investment in exploration is necessary to keep oil price in check. With investment being deferred, we could possibly see demand outstripping supply in the next 2 -3 years.

However, several factors could damp any positive movements in the oil price, such as:

1) An increase in the interest rate by the Federal Reserve which will strengthen the US$ and thus, potentially putting a damper on the price of oil.

2) Many of the US producers have drilled thousands of wells but have not completed them, pending a more favourable price before completing and producing.

3) The improvement in technology and ingenuity in techniques which will lover the breakeven price for US shale oil  producers. This will allow them to achieve profitability even at the present price range.

4) A change in policy affecting the Middle East that puts and end to the conflict or Iran's meeting the UN guidelines pertaining to the inspection restriction currently placed on the UN inspectors.

5) A US ruling which allow US producers to export their light sweet crude. This will effectively push more oil into the global market and putting additional pressure on the price of oil. It is expected in this regard that the price war between US producers and OPEC will intensify.

The is just my opinion. But having weighed in both the positive and negative factors, I think oil will likely to remain in the US$55 - US$65 in the next 6 months. The first signs of positive movement will be likely when substantial number of shale oil companies fail and file for bankruptcy. A rise in interest rate will also cut of funding from the debt market as the cost is likely to be high. Nevertheless, for successful shale oil companies which can survive at the current price range, I would expect them to ramp up production as soon as the price increases. So my personal estimate is that oil could only move marginally in Q1 2016, possibly, in the US$65 - US$70.