As oil prices have tumbled over the past year, numerous pundits and industry insiders have argued vehemently at one time or another that prices were about to rebound. However, while Brent crude prices have rallied briefly on several occasions, each rally has been followed by another plunge.
The fact is that oil bulls have nearly all made the same mistake -- underestimating the resolve of OPEC (particularly Saudi Arabia) to drive high-cost supply out of the market rather than cutting its own production. So far, OPEC hasn't blinked -- and there's no reason for it to change course now. As a result, oil prices could remain unusually low for another year or two.
Victim No. 1: Harold Hamm
Of all the people calling for oil prices to rebound, Continental Resources (NYSE:CLR) founder and CEO Harold Hamm has the most to regret. That's because he put his money where his mouth was in a big way late last year.
After calling OPEC a "toothless tiger," Hamm presided over the monetization of nearly all of Continental Resources' hedges. He called the decline in oil prices to around $83 a barrel unsustainable and said that cashing in on the hedges would allow the company to profit from a subsequent recovery in the oil market.
Of course, that recovery never happened. In fact, Hamm wasn't even close with his prediction, as Brent crude prices have spent the entire year below $65 a barrel. Continental Resources probably lost out on about $1 billion of hedging gains by monetizing its hedges prematurely. Meanwhile, Hamm's fortune plummeted by nearly $10 billion.
Victim No. 2: T. Boone Pickens
T. Boone Pickens is another oil billionaire who underestimated OPEC this year. He confidently predicted on multiple occasions earlier in 2015 that oil would rebound to $70 a barrel by the end of the year.
Pickens finally admitted a few weeks ago that he was wrong, because he hadn't banked on OPEC maintaining or even increasing its production levels. In fact, OPEC production has risen from around 30 million barrels per day (bpd) in the first half of 2014 (when crude oil prices were still above $100) to a high of 31.72 million bpd last quarter.
Falling U.S. production doesn't mean a thing -- for now
In the past few months, oil bulls have pointed to the falling U.S. oil rig count and declining domestic production to argue that oil prices will surely rebound soon. However, while U.S. oil production has fallen from 9.6 million bpd at the beginning of July to roughly 9.1 million bpd in recent weeks, that doesn't tell the whole story.
U.S. supply is falling and demand is rising at a robust rate, but because of higher production from OPEC, the oil market is no closer to being balanced now than it was a year ago. Declines in non-OPEC production combined with demand growth will need to outpace OPEC supply increases by a wide margin to reach a supply demand balance.
Notably, the International Energy Agency expects global demand for OPEC oil of 31.1 million bpd next year, despite a drop in non-OPEC supply of nearly 500,000 bpd. But as noted, OPEC has recently been pumping at a rate of 31.72 million bpd.
Furthermore, Iran believes that it can increase its oil exports by 1 million bpd within six months of the lifting of sanctions. If that occurs, other OPEC countries will be less likely than ever to cut production, for fear of losing market share within the cartel to Iran.
Depending on what happens with Iran, demand could catch up with supply in the seasonally stronger second half of 2016 or remain well below supply throughout the year. In the latter case, there would be little hope of balancing the market in the first half of 2017, when demand will drop seasonally. That could push the oil market recovery out to the second half of 2017.
In the meantime, the oil inventory glut will worsen. Ironically, the best hope for an oil market recovery in late 2016 might be if surging inventories drive an oil price collapse in the next few months, finally driving out even the hardiest unconventional oil producers.
Don't bet on politics
There are plausible scenarios that could catalyze an oil price spike within the next year -- or even within the next few months. Given the concentration of oil supply in the Middle East and ongoing geopolitical instability in that region, there's a constant threat of a major supply disruption.
It's also possible that Saudi Arabia and its allies will suddenly chicken out and decide they need to shore up their revenue right now, rather than waiting perhaps two years for the market to rebalance itself.
But these hopes and fears aren't solid ground for investing. It's probably a better idea to steer clear of oil stocks until demand is close to catching up with supply.