The oil market is oversupplied. While U.S. production is off its peak due to a declining rig count, Saudi Arabia and Iraq are producing at record levels. Combined with refineries in the U.S. and Europe shutting for their fall maintenance, things look very bleak for oil prices.
I think the market will make a run at $34 per barrel by March 2016; the first quarter of 2016 will look the bleakest. These are about the lows we saw back in December 2008 and early 2009. I predict crude oil inventories in the U.S. will rise to an 85-year high of over 500 million barrels.
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While low prices have helped the consumer with lower gasoline prices, very low oil prices will become a drag on the economy. In fact, low commodity prices around the world have detrimental effects on particular countries that in aggregate is bad news. Think copper for Chile and cocoa in the Ivory Coast.
Members of OPEC are feeling the pain as their economies slow down. States such as North Dakota, Texas, Wyoming and Colorado have increased spending based on royalty revenues from the industry. Now these states have to cut back and cope with job losses. And some cities are now seeing some decline in sales-tax revenues.
When oil prices decline, drilling declines and that leads to less demand for oil that has affected companies like United States Steel in Ohio. And of course if the factory closes, the local area economy of restaurants, doughnut shops and movie theaters get affected.
In Canada, oil sands prices are around $20 per barrel. The province of Alberta is in serious trouble due to the high concentration of oil production with layoffs and a serious contraction in investment. And this even leads to a decline in crude by rail shipments impacting the railroads.
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Very low oil prices are going to continue to affect crude-oil production and investment, but the flip side is that there is a lot of money on the sidelines looking to invest in this sector because many, like myself, are of the opinion that the low prices won't last for long. If your time horizon is two to three years, oil prices will recover and investing in producers, oil services and midstream companies will pay off.
And, oil production in the U.S. is declining. Demand is increasing and forecasts are being revised upwards. Investment in oil production is being postponed, delayed or canceled. The market has pretty much discounted all geopolitical risk around the world. Something will give and it may be social unrest in a place like Venezuela or Nigeria that results in a supply disruption triggering a price rise.