Wall Street Has a Dream About the Price of Oil

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The price of oil has bounced 20% since January 29 when the benchmark West Texas Intermediate had dipped below $44 a barrel, but according to Edward Morse, Citigroup’s global head of commodity research, that dizzying bounce is a “head-fake.”

Because the fundamentals are still terrible. Oil production in the US is still rising, despite drillers shutting down drilling activities at a record pace. Drilling fewer new wells is hurting oil field services companies, and the pain is fanning out across the oil patch and beyond. It hit private equity firms, it sank energy junk bonds, it triggered layoffs, but it isn’t curtailing oil production. Not yet.

So the US remains by far the largest contributor to “global oil supply growth,” the US Energy Information Administration just pointed out, with production in 2014 jumping by 1.59 million barrels a day. By comparison: in Iraq, the second largest contributor to global oil supply growth, production edged up by 0.33 million barrels a day.

And…

“Brazil and Russia are pumping oil at record levels, and Saudi Arabia, Iraq and Iran have been fighting to maintain their market share by cutting prices to Asia,” explained the Citi report, cited by Bloomberg. “The market is oversupplied, and storage tanks are topping out.”

Production will continue to rise, despite plunging drilling activity, and won’t slow down until the third quarter this year. As the oil glut is growing, it wreaks havoc on the price of oil, potentially pushing it, according to the report, into the neighborhood of $20 a barrel – “for a while.”

Analysts, faced with the oil glut that resulted from the US shale oil revolution, are scrambling to bring their erstwhile sky-high expectations into line with reality. They have slashed their projections for the energy sector; and according to FactSet, revenues are expected to plunge 36% in the first quarter. The plunge is so steep that it will drag revenue “growth” for all S&P 500 companies combined into the negative, -2.3% in Q1 and -2.6% in Q2.

And the US shale oil revolution has defanged OPEC. It can no longer control oil prices at will to maximize profits for oil-producing countries, including the US. A sort of an unpleasant free market has suddenly re-broken out. “It looks exceedingly unlikely for OPEC to return to its old way of doing business,” Citi’s report said. “While many analysts have seen in past market crises ‘the end of OPEC,’ this time around might well be different.”

But Citi is an integral part of Wall Street, and Wall Street dreams of a V-shaped recovery of everything because that’s where the quick and big bucks are to be made. Prices even in the current range are unsustainable for the industry, the report pointed out, and will entail a wave of “disinvestment from oil,” of the type we’re already seeing. But then, after oil plunges into the $20-range, presumably by no later than the third quarter, mirabile dictu, the price will soar, according to the report, and I mean SOAR, with Brent hitting $75 a barrel by the end of this year – more than tripling in a little over a quarter.

From $52 a barrel to $20 and then to $75 in just one year? That’s the kind of V-shaped recovery that dreams are made of. Every trader lusts for this. Wall Street lusts for it. Hedge funds can hardly contain themselves at the mere thought of it. So whose book is Citi talking up?

If the price of oil stays in the current range, liquidity for much of the oil patch will run out in 2016, and that’s when waves of defaults will begin to cascade through bank and private-equity balance sheets. And beyond that, investment banks stand to lose a lot: in 2014, Citi earned $492 million in energy-related investment-banking revenues – more than any other bank! More even than JP Morgan [How Wall Street Drove the Oil & Gas Drilling Boom That’s Turning into a Disaster].

So Wall Street must have a V-shaped recovery in place by 2016, or else.

We have watched the price of natural gas drop to ludicrously low levels – and stay there. Natural gas producers have been bleeding for years. Those that could, switched production to shale plays that were rich in oil, condensate, and natural-gas liquids that brought much higher prices and allowed some of these gas wells to be profitable. But now, their prices have plunged as well, and that solution has gone up in vapors. Yet, production continues to soar from record to record! There has been no V-shaped recovery in the price of natural gas. And if or when there is a price spike, it won’t be the right side of a “V,” but a spike after years of terrible bleeding.

OK, oil is different. It’s a global commodity, which landlocked US natural gas is not. And there was a V-shaped recovery after the financial crisis as the central-bank money-printing binge around the world inflated nearly all assets. This time around, there isn’t a financial crisis, and no sudden collapse in global demand. Instead we have lackluster demand, rising production, and increasingly a glut. And the Fed, the biggest perpetrator at the time, is sitting on its hands. So that breath-taking, stunning V-shaped recovery back to paradise might remain what dreams are made of.

Meanwhile, far from Wall Street, and out in the oil patch, the cutbacks in the exploration-and-production sector are hitting oil-field services companies hard. They too are cutting back. The impact is rippling out further. And the bloodletting will go on. Read…  Oil Rig Count Plunges 29% from Peak. Halfway to Bottom?

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  8 comments for “Wall Street Has a Dream About the Price of Oil

  1. pete
    Feb 9, 2015 at 6:37 pm

    Hey Wolf…these big-bank forecasters…where were they last year???…forecasting $20 oil or $150 oil??? They’re worse than clueless – they’re dangerous – because last year thy were lending on the basis of their senior economist ‘fantasy’ forecasts.

    On Thanksgiving nite I thought maybe twenty, but with all these idiot economists forecasting lower, maybe the bottom’s been made already.

    Best…PJS

    • Feb 9, 2015 at 8:37 pm

      Now they’re talking up their book. They’re good at that.

      • Perfected democrat
        Feb 10, 2015 at 3:36 am

        Ha ha, why I read wolf…

  2. Dan Romig
    Feb 10, 2015 at 7:33 am

    It all comes down to the Saudis. ZeroHedge has run some interesting articles on the Saudi motivations that I believe are true.

    It’s amazing that in a world that consumes nearly 90,000,000 barrels a day, a swing of a couple percentage points of supply can bring the price down in half. Could that work in reverse?

    • SteveK9
      Feb 10, 2015 at 10:12 am

      Agree. The ideas that OPEC (Saudi Arabia) is out of the game is wrong. They want to inflict so much pain on the shale guys (and the banks) that even when prices start going back up in a year or two, they won’t be jumping back in for some time.

  3. Paulo
    Feb 10, 2015 at 8:03 am

    re: “If the price of oil stays in the current range, liquidity for much of the oil patch will run out in 2016, and that’s when waves of defaults will begin to cascade through bank and private-equity balance sheets.”

    Just in time for the 2016 election. That should be interesting and stupid dialogue.

    “Hey Michelle Bachman, there is $2.00 oil. How’s that working out for everybody”?

  4. Gil Obrero
    Feb 10, 2015 at 8:20 am

    Th thing that never ceases to amaze me is how they cannot see the links .
    When I see iron ore doing a v shaped and cement and lumber futures around the globe, not to mention copper, the BDI which hit all record lows over 30 years, mind, i haven’t even thought about that in terms of inflation linking, but clearly shipping needs a bit of Citi quackery too, but with global GDP due to collapse over 2 trillion this year, I see massive potential for investors to buy buy buy oil now as though it somehow has decoupled from everything else, and buyers are out there just itching to buy at the end of the year to……….well to melt all that cheap iron ore of course. That no one wants

    You have to laugh or it would bring tears to to your eyes the stupidity of some people

  5. Feb 10, 2015 at 1:39 pm

    I’m confused where this V-shape is coming from. CME’s WTI Futures shows no such drop to $20– anyone who’s betting that is pretty far off the betting lines….

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