20 is the New 40: Understanding and Forecasting the Oil Plunge

The oil industry is in one of its deepest downturns since the 1990s. On January 15, oil prices crashed six percent, with the Brent and WTI Index both closing at below $30 a barrel for the first time in 12 years. To put that in perspective, that is lower than it was in the midst of the 2008 financial crisis, the worst global economic downturn since the Great Depression, according to analysis by the Financial Times. It is clear that what initially began as a small price drop has ultimately resulted in an 18-month long plunge. Even worse, there seems to be little possibility for a recovery in the immediate future.

To understand the bleak state of the oil market, one must first understand the mechanics that are behind its trajectory. In 2014, crude oil prices peaked at $115 a barrel, almost four times what they are now. At first, many economists predicted that oil would continue its upward trend and fully rebound to pre-recession prices. However, a number of factors contributed to its slow, but continuous, downward slide. To begin, China, one of the biggest importers of crude oil, saw annual economic growth of only 7.4 percent in 2014, its lowest rate in 24 years. For the first time since its rocket-like expansion, it had missed its growth rate target.

Since then, the Chinese market has undergone a roller coaster-like trajectory, galvanizing government intervention and economic stimulus. While the stock market has no direct effect on oil prices itself, its fall has reinforced global concerns that the Chinese economy is heading for an abrupt slowdown, thus undermining future expectations for the sales of oil. Therefore, it comes as no surprise that the Shanghai Composite Index and the Brent Crude Index have closely mirrored each other.

The second and largest contributing factor to the decline has been the recent international glut of crude oil. Hyper-competition between oil producers desperate to cling on to their market share has lead oil production to surge over 95 million barrels of oil a day, despite declining prices, according to reporting by the New York Times. Crude oil inventories have swelled to the highest level on record. This rise in oil supply, unmatched by an equivalent rise in demand, has therefore put downward pressure on prices. Analyst Kevin Book of ClearView Energy Partners predicts that that this oversupply will continue at least until the last quarter of 2016. To make matters even worse, many of the world’s largest economies, the United States as a prime example, has moved to increase domestic production, diminishing the demand for foreign oil.

Lastly, the rallying U.S. dollar has made crude less attractive to overseas buyers. As is with any other commodity, Oil is always and only bought in U.S. dollars. Over the past year, the dollar has become stronger against most currencies. As a result, foreign importers are finding themselves spending more to buy crude oil, as they must exchange more of their local currency for each dollar.

With oil prices this low, many investors have argued that there is only room for rebound. This is undoubtedly false, as most of the factors contributing to the slide in oil prices, including China’s slowdown, supply-demand imbalance, and a the strong dollar, are likely to continue. Despite heavy economic stimulus, China will be unable to stimulate growth as it has once before, with this year’s growth projected to be only around 6 percent, according to the Straits Times.  Similarly, many emerging markets particularly in Latin America, the Caribbean, and parts of Asia and Europe are also facing economic contraction. As a result, these countries will weigh heavily on the global economy. In January, the International Monetary Fund revised their global economic outlook, lowering their growth expectations for the world economy down to 3.4% for 2016.

Lastly, the glut of oil is likely to see little to no resolution in the immediate future. With major exporters refusing to slow down production and Iran expected to become a major exporter of oil again under the nuclear deal, there is a serious possibility of the oil market not rebalancing until the last quarter of 2016. Iran’s oil minister Bijan Zanganeh believes that Iran will export 500,000 barrels of crude a day in the immediate post-sanctions period. In the six months after, this amount is set to double, with Iran exporting up to 1,000,000 barrels a day.

Thus, with oil supplies ready to rise, China’s wide-impacting economic slowdown, and rather mild predictions for the global economy in 2016, it is clear that the price of oil has nowhere to go but down.