Is Crude Oil Ready To Recover? Maybe in 2015... For the month of November, the Manufacturing Institute for Supply Management (ISM) reading was 58.7, marking the 18th consecutive month of manufacturing expansion in the U.S. Anything above 50.0 denotes growth, anything below, contraction. Among the areas that showed particularly strong growth were new orders and exports. But while the U.S. continues to expand, the rest of the world cools or, at best, remains in a holding pattern. The J.P.Morgan Global Manufacturing Purchasing Manager’s Index (PMI), released on Dec. 1st, registered a 14-month low of 51.8. Had the U.S.’s individual score not been as strong, the global PMI number might not have exceeded the expansion threshold. The eurozone and China were the largest drags on global manufacturing. Whereas Europe registered a 50.1 for November—even usually dependable Germany scored a 17-month low of 49.5—China remained flat with a 50.0, the country’s lowest reading since May. Just as the U.S. is the standout in manufacturing growth, its also now the world leader in oil production, thanks largely to hydraulic fracturing. The two combined—global slowdown and abundant oil—have prompted the rapid decline in prices. Not only is the global PMI at a 14-month low, but it also marks the fourth-consecutive month that the one-month reading has stayed below the three-month. When global manufacturing has slowed in the past, so too has oil demand, driving prices down 7 percent 100 percent of the time. Today, crude has fallen much more steeply than that—35 percent since June—but other factors have contributed to the recent slump, from the strong U.S. dollar to oversupply fears. So short of an unexpected jumpstart to global manufacturing, how else might oil break out of its trough? The theme going into 2015 is mean reversion. Oil prices are below where they should be, and hopefully they’ll start gravitating back to the equilibrium price of between $80 and $85 a barrel. Crude oil is currently down 1.2 standard deviations for the 10-year period. This might not sound like much, but as you can see, oil has rarely gone above or below one standard deviation during this time. Plus, its wild volatility during the financial crisis rejiggered the commodity’s mean. What the oscillator above also shows is that oil has eventually returned to where it should be, as it did not only after the financial crisis but also in the third quarters of 2011 and 2012. Barron’s pointed out in a piece published this week that “prior price slides lasted roughly 20 weeks. The current slide is already at week 24. History suggests the panic… is near its end.” Indeed, oil markets have historically been quick to recover because exploration and production become unsustainable otherwise. Several shale regions in Texas were already unprofitable at $75 per barrel. At $70, expect more companies, especially those involved in fracking and deepwater drilling, to cut production even further. The problem is, they really can’t afford to do so. It currently takes output from four or five new wells to replace the cost of one previously drilled unconventional well, which is why companies must keep up with exploration and production. And that’s just in the U.S. Many countries whose economies rely on oil exports, including Russia, Venezuela and Nigeria, will be unable to balance their budgets with $65-per-barrel oil. Though not yet underwater, Saudi Arabia might soon begin to feel the pinch, as Brent is getting treacherously close to the Kingdom’s breakeven price, which has risen about $10 per barrel in only five years.
Posted on: Sat, 06 Dec 2014 14:42:41 +0000