WILL OIL DROP FURTHER?

Oil is now trading at US50.17 per barrel.

The sharp drop was brought about by two factors:

1) The conclusion of the Iranian deal to lift sanctions.
2) The increase of US crude in storage vs a forecast of a fall.

The Iranian deal came as a surprise as Iran's parliament earlier voted not to allow the inspectors access to its military bases. In fact, a few analysts (UBS & Boone Pickens) have expected that oil will recover steadily towards year end to about US$70 per barrel. The surprise deal means that Iran can immediately release oil still in storage to the market and may add between 500,000 to 1.0 million barrels a day by 2016.

This has led many to believe that oil will stay in the US$50 - US$60 for a very long time.

However, there appears to have a strong reaction from Congress, and there could be some resistance against the deal. However, the President can veto any move against the deal.

Across the divide, there is Gary Ross from PIRA who predicted that oil could return to US$100 per barrel in 5 years.

The recent increase in crude production could be due to the shale oil producers needing to produce more and more before their hedging expires this year. Many are already scaling back dividend payment, capital expenditure and laying off staff in order to meet the debt payments. And increasingly Wall Street is getting impatient with the shale oil companies and may review their financial position in Q4 this year. If the Federal Reserve increase interest rate then, the pressure will be even greater as the shale oil companies need to source for funds to continue drilling amidst funding becoming more and more expensive. There is a debt crisis in the making here and likely we will see many filing for Chapter 11 by Q4 this year.

I believe that oil could stay at US$48 - US$55 levels in the short term as the impact of Iran is priced in, but oil could move above this band as the shale oil industry collapse under its own weight due to its high debt to EBIDTA ratio. Even when oil was at US$100 per barrel many were hardly generating positive cash flow.

So the year end forecast would likely see oil trading at around US$55 - US$65 per barrel.

I very much agree with Gary Ross that oil could return to the high of US$100 per barrel, not in 5 years but perhaps in the 3 -5 years period as Big Oil cut their Capex on deep water exploration and drilling in the costly areas such as the Arctic. In the absence of such explorations to discover new productive wells, we could see supply falling behind demand. This will tip the price of oil on the high side..

The above are just my opinion.