$75/bbl for Brent by June... or not, one of the two

Predicting the future is hard, particularly if you attach a date to your prediction as then observers can pretty easily work out if you were right or wrong. No one likes being wrong, so most soothsayers try to avoid this trap by being wooly about the timing. In my very first post about the oil price I was just as cautious, with a vague prediction that in the long run prices would oscillate around about $80/bbl.

That's what I still think, but by neglecting to mention whether I meant $80/bbl in 2015 money or in the money of the (future) day I also gave myself quite a wide band within which I could still claim victory if anyone bothered to check my post again in 2025.

I don't make predictions lightly, though. What I like to do is look at the data and see if there is something lurking there that gives a clue as to what might happen. When I analysed prices before what I noticed was that recently OPEC wasn't losing market share at prices of $80/bbl, in fact at that price OPEC's market share still grew ever so slightly. It took prices of more than $100/bbl for a couple of years before OPEC's share started to slip. In the early eighties, OPEC put price before market share, their market share collapsed from 45% to less than 30% in less than five years, and they reaped two decades of low prices before demand growth outstripped supply growth and finally tilted market power back into the producers' hands.

Oil prices since 1965, in 2015 dollars with both total world oil supply and OPEC market share and spare capacity shown in the background.

Oil prices since 1965, in 2015 dollars with both total world oil supply and OPEC market share and spare capacity shown in the background.

Some distinguished commentators, I'm looking at you Mr. Kaletsky, missed this fundamental difference between what happened in the eighties and what is happening now and concluded that "the trading range in the brave new world of competitive oil should be roughly $20 to $50." 

OPEC isn't going to repeat the errors of the early eighties, they have decided that maintaining market share matters more than price and if it takes a year or two of low prices to protect market share that is just what OPEC will do. However, if OPEC can build market share at $60 to $80/bbl, why on earth would they let oil trade at less than $50/bbl?

So I still believe that $80/bbl (in 2015 money) is the Goldilocks price; not too high for consumers to want to buy more delicious liquid energy and not too low for producers to keep investing in oil field developments.

However, the question vexing me, and countless other people with a vested interest in oilfield development projects, is a simple one – how much longer do we need to tolerate low prices before the market wants to put capital back into the oil sector? When I speak to brokers about raising capital for our project I am told the market is shut, they would rather put their effort into other sectors. That is probably true today, but I think sentiment will change soon and change quickly. I am predicting we will see the Brent oil price at $75/bbl before June is out, and that investors will want to be back in the oil sector before all the bargains have gone.

Just a technical note here, because a share is cheap compared to its price last summer doesn't mean it's a bargain, sometimes it means it's rubbish. Of course separating the rubbish from the bargains is the art of investing and I am going to steer well clear of that.

So why do I think that there is a turn in the market coming? Well as usual it is because I have been drawing a graph. Here is my latest graph.

Data from Commodity Charts; Cash contract for Brent and the furthest dated Brent contract deflated back to 2015 at 2% per annum, blue shaded area is the spread between cash and deflated future price.

Data from Commodity Charts; Cash contract for Brent and the furthest dated Brent contract deflated back to 2015 at 2% per annum, blue shaded area is the spread between cash and deflated future price.

The black line is the Brent oil price for cash settlement on the day; the green line is the furthest dated contract deflated back into today's money at 2% per annum. At the beginning of the chart that contract was dated December 2012, at the tail end of the chart it was dated December 2022, but because I deflate the number when I switch contracts it is almost impossible to see the shift.

When I look at this chart I see two separate regimes governing what is happening. From July to November 2014, the high prices producers had been enjoying fell pretty rapidly without troubling the long dated future price much at all. When my dataset starts at the beginning of July the Brent oil price was $110/bbl and the future price for December 2021 was $95/bbl which deflates back to $82/bbl. By the 26th of November Brent had fallen more than $30/bbl to $79/bbl but the deflated future price had stubbornly resisted the decline and had only slipped, less than $3/bbl, to that very same price, $79/bbl.

So the 26th of November is exactly where my green and black lines cross over. Up to that point all the action in the market was in the next month contract; but at the end of November the game was in transition, and if we follow Jose Mourinho's thinking, it is when the game is in transition that everything interesting happens. Producers looked at the futures market, their balance sheets and their cash costs and started to lock in future prices as fast as they could. And what happens when sellers rush into a market, the price goes down. By Christmas the deflated future price was $67/bbl. Having fallen less than $3/bbl in about five months while the near term price had collapsed over $30/bbl, the long dated price fell over $12/bbl in a month. The futures market had the ball and was driving the current price down with it.

Of course the near term market overshot, it has to, it is more volatile; but I would argue that from December 2014 to about the beginning of April 2015 it has been the long dated market that has had the ball and which is shaping the game.

But I think we are on the verge of another transition. The long dated price is no better than today's price, there is no pressing incentive for producers to lock in future prices that are no better than today's price. The production companies are about to step out of the game, and what happens when sellers decide to leave a market, you guessed it, the price goes up.

This time I think the move will be a bit less dramatic than in December, maybe a five dollar shift up in the futures price, but the near term market will overshoot and by June I expect Brent to be trading at $75/bbl or thereabouts.

Of course something could happen that changes everything and undermines my every premise, so just in case, I will round out my prediction with a caveat. The Brent oil price will be $75/bbl by June, or not, one of the two.