This may have been one of the crazier weeks the oil market has seen in many years. Tuesday, oil jumped 7%, only to give that back on Wednesday, and by Friday, the black gold was up 3% after another good jobs report. By the end of the week, crude oil futures were up 7%, to $52.07 for a barrel of WTI crude, and $58.13 for a barrel of Brent crude.
Where do prices go from here? No one knows for sure; but here's what we do and do not know about crude oil that could drive its direction in the next year.
What we know
Crude oil prices have tumbled during the past six months for two main reasons. First, oil markets are oversupplied by 1 million to 2 million barrels per day, and stockpiles are piling up. In the U.S., non-strategic petroleum reserve stockpiles hit their highest mark on record last week, and there appears to be no stopping the momentum given expected production growth in 2015.
The second thing that has driven oil lower in recent months is the realization that OPEC will not be cutting production to keep prices near $100 per barrel. Instead, OPEC has said it will maintain production at 30 million barrels per day, a figure it has actually exceeded in recent months. Without OPEC to prop up oil prices, which they've done for years, there was little for oil to do but fall.
Where does that leave us today? Companies and countries are beginning to react to the market's oversupply, low prices, and OPEC's resolute production numbers. Here's what we know about how the market is reacting.
- Drilling spending will be down in 2015: In the U.S., companies have rushed to cut drilling and capital spending programs in 2015, which will slow the growth of domestic oil production. Every company from big oil companies Chevron and BP to small shale players Continental Resources (NYSE:CLR) and LINN Energy are cutting back drilling, so the reaction is widespread. This should ease some of the oversupply in the market, except for one problem.
- There's a long lag between when drills stop and oil production growth stops: Drilling for new wells is slowing, but production at existing wells isn't going to stop overnight. As a result, the EIA recently predicted that U.S. oil supply would increase 600,000 barrels per day to 9.3 million barrels in 2015, despite low oil prices and slowing drilling. Oversupply should ease, but it will take time.
- Gas guzzlers are back in style: One of the side effects of low oil and gasoline prices is that customers will trade up to larger, less efficient vehicles. According to Autodata, vehicle sales were up 13.7% in January from a year ago, and a whopping 54% of sales were trucks, vans, and SUVs. At least in a small way, a rise in consumption will ease oversupply in 2015.
That's some of what we know about the oil market early in the year; but what may be more important is what we don't know. That's what will either drive the price of oil back to $100 per barrel, or keep it below $50.
What we don't know
A lot can change in a heartbeat in the oil market. Just ask Continental Resources CEO Harold Hamm how quickly a $20 billion fortune can be cut in half by forces almost completely out of your control. Here are a few questions we don't have answers to that will have a huge impact on oil prices during the next few years.
- When will oil supply actually begin to fall? I highlighted above that we know oil companies big and small are cutting back on drilling for new oil, and we know there's a lag between that decision and production dropping. The problem is, we don't know when production will start to fall. It could be next week, it could be this fall, or it could be in 2016. When production begins to fall will say a lot about if and when oil prices begin to rise in a sustainable way.
- What will OPEC do next? No one, not even OPEC itself, knows what OPEC will decide to do at its next meeting or at an emergency meeting in the spring. Will they cut production by 1 million or 2 million barrels to boost prices? Will they stand pat? Maybe they'll increase production to squeeze Russia and U.S. oil producers even further. The cartel is a wildcard, and that's always been the case in oil markets.
- China is growing, but how much? The developed world has been reducing consumption of oil for more than a decade, but China has more than picked up the slack. This has kept the price of crude oil high. Will that be the case in 2015, or is the country in for a slowdown? This may be the most important demand question facing the oil market.
The only thing that's certain is uncertainty
The bottom line is that we don't know where oil prices are going to be in a month or a year -- we can only see how current prices are impacting the industry today. Based on that, I think we'll see higher oil prices in the next year or two, but we won't see $100 per barrel. One hundred dollars clearly led to an unsustainable boom in oil drilling, but $50 per barrel is seeing the opposite effect, killing drilling in the U.S. and other parts of the world.
Neither is sustainable long term, so somewhere in between seems about right. But where oil lands is anyone's guess. The only thing I know for sure is that the oil business as a whole isn't going to go away; it's just going to change and evolve as it has done for more than 100 years. Maybe uncertainty is the only thing we should really expect from oil markets today.