We expect the oil price to remain volatile for a number of months, with a recovery to $75+/bbl likely over the next 12 months. A necessary part of this outcome is for US oil shale growth to fall back by the end of 2015. After 2015 the likelihood is that the price will fluctuate quite widely, but move on an upwards trajectory as accelerating emerging country demand growth and flattening US shale oil growth slowly tighten the global oil supply/demand balance.

The oil price at $50-60/bbl is not yet at an economic extreme, leaving a reasonable chance that it continues to decline while the market starts to rebalance. An oil price in the $50-60/bbl range is not high enough to justify new investment in higher cost and more marginal non-OPEC projects. However, it is not low enough to warrant existing high cost producers to shut in reasonable volumes of supply. We believe that oil prices would need to fall to around $35-40/bbl to warrant this.

Saudi and other OPEC members are acting rationally in their response to the falling oil price. OPEC’s decision not to cut production is borne out of a realisation that the falling price is principally a function of non-OPEC over-supply, making ‘emergency’ quota cuts a fools’ errand as they would simply encourage more non-OPEC growth. We sense that Saudi are eyeing US shale oil growth and would prefer a shallower oil price recovery for the time being (i.e. one that doesn’t allow US oil growth to accelerate unabated), rather than a ‘V’ shaped recovery that restores it to $100/bbl. If we are right, it is logical for Saudi & co to tolerate a lower oil price for as long as it takes to achieve this.

David Fuller's view

Here is Tim Guinness' Letter.

I do not see this as an OPEC agreement.  It was a Saudi-led decision for the predominantly Sunni producers – Saudi Arabia, Qatar, Kuwait and the UAE - to keep pumping, weakening the growing and predominantly Shia Iran / Iraq alliance, while also curbing non-OPEC supplies from US shale oil to Russia’s production. 

I maintain that this will be a Pyrrhic victory, at best, for the Saudi-led group.  They will be hoping for a replay of 1985-87, when they refused to cut supplies at a time of oversupply.  Veteran subscribers will recall the Crash of ’87, which temporarily lowered demand.  Even more importantly, there was no visible acceleration in oil producing technology, no fracking and negligible renewables. 

I assume that a partial recovery could start with a sharp bounce, as there will certainly be some significant hedge fund short positions, in addition to some likely short selling by the Saudi alliance.  However, once oil prices approach $75+, assuming they get that far, fracking will also pick up.  Additionally, there are other non-OPEC suppliers, such as Mexico, which are in a position to increase production considerably.  The production of natural gas will also increase this year.  The number of solar panels will continue to increase every year, as will the efficiency of the latest units.  Automobiles will mostly be fuelled by gasoline, but ever more efficiently.  Large trucks can and will continue to be converted so that their fuel becomes natural gas, which is less expensive, rather than gasoline made from crude oil.  

I doubt that oil usage has peaked, although it obviously will at some point.  However, OPEC will never regain its former control, in my opinion.  Even without the increasing number of substitutes for crude oil, many countries have abundant reserves of shale oil, as yet untapped.