Wednesday, November 12, 2014
I'd like to update my views on crude oil in today's post.The chart you see above is a monthly bar chart of West Texas crude oil futures for the past 30 years, the entire history of futures trading.
I have been a bear on crude ever since the fracking boom in the US started rolling in 2008. Right now I see nothing on the horizon which would change my view that crude oil prices above $100 are unsustainable.
I think there are two kinds of bear markets in crude oil. The Papa Bear drops prices 75% or more. We have seen three examples of this during the past 30 years (first three blue rectangles). The Baby Bear drops prices 40-50% (first two purple rectangles). The question in my mind now is just what kind of bear market started from the 2011 top in crude around $115.
The optimistic scenario would give us a 40-50% drop from that high into the $58-68 zone (last purple rectangle). I keep hearing assertions that prices below $68 would start putting higher cost fracking operations out of business temporarily. So this $58-68 range has a certain plausibility and is a conservative downside target. That zone may well represent "fair value" for crude oil for the foreseeable future.
But in my experience a market like crude oil which has been trading far above fair value for a long time rarely stops at fair value on the way down. Instead prices continue dropping to well below fair value in order to shut off the excess supply which comes onto the market on its way down. This supply is showing up now as with US crude oil production ramping up.
So I think there is a very good chance that crude oil prices began a Papa Bear market from the $115 level in 2011. If I am right about this we will probably see crude oil prices return to their 2008 lows at $33 or go even lower during the next couple of years. This won't be good news for oil producers. But for the rest of the world economy such a drop would amount to a huge tax cut and add to the support beneath equity prices which is currently being provided by the quantitative easing policies of central banks.