When Will Crude Oil Prices Turn Around?

As crude oil prices continue their race to the bottom of the market, new data released this week shows oil supplies around the world -- especially in North America -- are way in front of demand, which is at its lowest level in more than a decade.

The Organization of the Petroleum Exporting Countries (OPEC) released its monthly supply-and-demand forecast for the global crude oil market on Wednesday, a day that saw the January crude oil futures contract trade just over $61 a barrel. That's down almost $15 per barrel since the Thanksgiving holiday.

The report forecasts that the market that's already lost more than 30% of its value from early 2014 will continue to fall well into 2015 based on growing supplies and stagnant demand around the world, with one major exception: China.

World demand for crude oil has grown in the last year, just not as much as earlier estimates; a number of factors are behind the slide in the U.S., Europe and most of Asia, the greatest one being generally slower economic activity, according to Tuesday's OPEC report. However, things are different in China, which is making up for part of the slowdown elsewhere.

"Demand in OECD Americas has been revised down as transportation and other sectors were impacted by greater efficiency and fuel substitution, despite improving economic activities, and solid growth in distillate consumption in the U.S. In OECD (Organization for Economic Cooperation and Development) Europe and Asia Pacific, a number of factors have contributed to the lower-than-anticipated oil demand growth this year, such as slower economic activity, the sales tax hike in Japan, and increased fuel switching," according to Wednesday's report. "In the non-OECD, oil demand was revised down mainly in Latin America, other Asia, and the Middle East. This was due to slower economic momentum, the partial removal of subsidies, and geopolitical tensions. At the same time, booming demand for petrochemical feedstocks, as well as an uptick in transportation fuel requirements, supported oil demand growth in China. In 2015, with global economic activity expected to increase, world oil demand is projected to grow at a higher rate of 1.12 million barrels/day."

Global economic growth is typically a good indicator of oil demand; as an economy grows, so does its oil consumption. The economies of North America and Europe are growing, and China's is projected to stay static in its economic growth in the coming year. But China is projected to up its oil use, while use is projected to slide in North America, an inverse relationship between growth and oil demand in 2014 and 2015.

"The world economy continued to recover in 2014, growing at 3.2%, and is expected to pick up pace to 3.6% in the coming year. The U.S., in particular, gained momentum in recent months amid an improving labor market. While the situation in the Euro-zone has remained tentative this year, some relative progress in peripheral countries has helped to lift growth. Japan has been negatively impacted by its April sales tax increase and remains dependent on monetary stimulus," according to OPEC's report. "Overall, the OECD is seen growing by 1.8% in 2014, increasing to 2.1% next year. In the emerging economies, China’s growth is expected to remain at around 7% in both 2014 and 2015."

This seeming inverse relationship suggestst that OPEC is looking to reestablish demand by keeping what it considers "marginal producers" out of the sector. Domestic oil supplies are at multiyear highs -- and demand is at multiyear lows -- in the U.S. for a few reasons, but the largest is clear: Growing production in the Bakken Formation region of the northern Plains. This is not good for OPEC producers, and Wednesday's report is proof that supply and demand fundamentals aren't the only factors dictating world oil price.

"You would think that lower prices beget higher demand, so OPEC’s comments seem counterintuitive.  That said, it’s pretty clear that OPEC has an agenda that includes driving out the marginal producer whose cost of production is relatively high. The largest collective marginal producer that OPEC has in its sights is the Bakken producer," says Peter Meyer, senior director for agricultural commodities at PIRA Energy Group. "Vehicles throughout the world have become more fuel-efficient but to say that demand will just drop off the table in the coming year is a bit suspect and suggests an ulterior motive."

World economic analysts and leaders have for months braced for the inevitable announcement from OPEC that production would be slashed in order to stoke demand via shorter supply. That hasn't happened yet, and though many suspect it's a consequence of OPEC leaders' inability to reach a conclusion on the matter, there's specualation that it may not happen at all.

"Right now, crude oil is just weak on supply factors. I think we're seeing increased U.S. production and increased world production. We see it in the grains all the time: When prices go down, what do you do?" says U.S. Commodities grain market analyst and broker Jason Roose. "Plant closer to the fencerow so you have more product to sell. When prices go down, they may not produce less; they're going to produce more to make up for that lost price differential."

So, how low will crude oil prices go before they bounce higher? They don't have a whole lot of distance left; Meyer says he expects around $50 a barrel to be the point at which investors return to the oil market, while Roose says it's a few dollars higher. Either way, that point is close, so the slide in oil -- and its effects on the grain markets -- may be winding down.

"As far as where investors step in, it’s all psychological at this point with $50 as good a level as any. With Brent trading around $65 and WTI seemingly on its way to $60, producers have to be hurting at these levels, but it doesn’t seem like anyone is willing to pick a bottom yet. There’s no magic to the $50 level; it just might bring some psychological buying to the market," Meyer says. "I would also think that should oil prices get down to $50, the marginal producers will definitely pack up while the larger producing countries of OPEC slow down their output."

Adds Roose: "I'm hearing breakevens around $54. The people I talk to tell me we have plenty of energy in the U.S., just problems with transportation. Our distribution has been slow and it's creating a backlog."

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