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Why oil and gasoline prices could plunge

Why oil and gasoline prices could plunge

A big boost in domestic oil production during the past two years hasn’t led to big energy savings for Americans. But that may be about to change.

Oil prices may plunge by the end of the year, according to Zach Schreiber, CEO of hedge fund PointState Capital, who made that call recently at the annual Sohn Investment Conference in New York. “We believe crude is going lower — much lower,” Shreiber said at the conference. “The oversupply of North American crude has not been felt yet.”

Schreiber declined to provide numbers, but his presentation suggests West Texas Intermediate, or WTI — the type of high-quality oil typically extracted in the United States — could fall from about $100 per barrel now to $85 or less by the end of the year. That’s the level at which drillers might curtail production, as falling prices hurt their profitability. “Production won’t slow meaningfully until at least $80 to $85 per barrel,” Schreiber said.

A minority view

Oil prices are notoriously difficult to predict, and Schreiber’s is a minority view. Citibank’s top oil analyst agrees with him, saying oil prices will fall to around $75 during the next couple of years. But Chevron is planning for oil at $110. OPEC, the Middle East oil cartel, predicts rising demand will push prices up. And the U.S. government predicts WTI prices will end the year at about $96 per barrel, then fall to about $90 by the end of 2015.

Schreiber believes WTI is overpriced because technical and temporary factors are making an oversupply of oil seem like a shortage. Oil inventories in Cushing, Oklahoma — a key transshipment point — are low, suggesting scarcity. But more oil than usual is piling up near Gulf Coast refineries, which are operating at maximum capacity. “The market is fixated on Cushing,” Shreiber says, “which is a temporary island of scarcity in the middle of a sea of crude.”

For all the talk of a U.S. oil boom, new drilling techniques such as hydrofracking have only begun to push up domestic production. U.S. crude production fell consistently from 1985 to 2008, then ticked up for a few years. The first real spike in production didn’t occur until 2012, as the following chart shows:

That increase in U.S. production occurred at the same time output fell in Libya and Iran, keeping global supplies more or less in balance, and prices stable in the ballpark of $100. Gasoline prices track oil prices closely, as the next chart shows, and with oil fairly steady, U.S. gas prices ranged between $3.30 and $3.70 per gallon for most of the past two years.

If oil fell to $85 or lower, that would probably push gas prices down toward $3, an obvious boon for consumers. Other factors affect pump prices — especially refining capacity — but it also helps that Americans are driving less and cars are increasingly efficient, keeping demand for gas softer than it might otherwise be.

International factors seem to favor lower prices as well. Iran and Libya are both bringing more oil to market just as U.S. production is kicking into high gear. That oil isn't quite the same as WTI, but it has a similar effect on markets and prices. China’s demand for oil has a big impact on price — and the Chinese economy may be slowing to the lowest growth rate since the 1980s, which will likely reduce its demand for oil.

There’s also talk of ending the ban on U.S. oil exports, which would ease the glut of oil awaiting a spin through U.S. refineries. But that wouldn’t necessarily push prices up, since new overseas markets would give drillers more incentive to produce.

If oil prices do fall, it would aid U.S. consumers and businesses while trapping speculators gambling on prices going the other way. But if prices fall too far, it will no longer be profitable to drill for the costliest oil, which will put a floor under prices. The real question is how low the floor can go.

Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.

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