Oil Capitulation, Served Two Ways
Before you can pick yourself up off the canvas, you have to hit it. Oil analysts and investors right now have their ears cocked for that tell-tale thud.
It certainly seems to be near, judging from the rising number of analysts throwing around expletives like "$20 a barrel." Wednesday's weekly U.S. oil inventory report was equally offensive, with a toxic mix of higher imports, surging stocks of gasoline and diesel and falling demand.
Capitulation is a fuzzy concept, though, and a gap has opened up between two important indicators for the oil market.
Futures are pricing in a lower-for-longer scenario for oil that seems unconcerned about geopolitical risk, falling upstream investment or demand being better than anticipated. This may reflect heightened fears about a slowdown in China and other emerging markets or the longer term impact of shale development, as I laid out earlier here. In any case, futures have flattened compared to 18 months ago, before the crash.
Meanwhile, the chart below shows how median analyst forecasts of average Nymex oil prices from 2016 through 2019, based on Bloomberg surveys, have moved over time.
Clearly, these have also moved down. Still, there are some important differences between what the analysts expect and what the market expects. The most obvious one is that the consensus remains significantly higher than the futures market.
The second, more subtle difference concerns the duration of low oil prices. While talk of $20 oil is no longer laughed out of the room, it is clearly seen by most as at worst a brief bungee jump: truly frightening but mercifully short. The chart below shows the same analyst consensus but from a slightly different perspective.
The consensus is for oil to bottom out this year and then recover through at least the following three years. Indeed, these lines understate the true expectation, as they are based off the consensus forecast for 2016 of $50 a barrel, rather than the current futures level of about $35. On that basis, the consensus for 2017 actually implies an increase of almost 70 percent from where the 2016 market price is right now.
There is an element of mean reversion at play here: Before the crash, median forecasts implied oil simply continuing to bob around the $90 level for years to come. And $20 or $30 oil is clearly unsustainable for a large part of the oil industry, meaning lower investment and production outside of OPEC will eventually rebalance the market at a higher price.
How quickly that happens, especially in light of renewed pressure on emerging markets, is as critical a question as where and when the price bottoms out. Right now, analysts expect oil to rise from the canvas pretty quickly, while futures still look down for the count.
To contact the author of this story:
Liam Denning in San Francisco at firstname.lastname@example.org
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Mark Gongloff at email@example.com