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Oil at $33: how much lower can it go?

Oil prices fell below $33 a barrel on Thursday – levels not seen for 12 years –after market turmoil in China tested the nerves of investors around the world.

Benchmark Brent crude for February delivery was trading at $33.57 on Thursday, down 66 cents or 1.93 percent, having recovered from more than a 5 percent fall overnight to a low of $32.16, the lowest level since April 2004.

Meanwhile, U.S. crude futures also dropped more than 5 percent to a low of $32.10 per barrel, a level not seen since December 2003, but had since recovered to $33.13.

The price of oil has fallen around 70 percent since June 2014, when a barrel cost around $114. Since then, a glut in global supply and demand failing to keep up – as well as the decision by major oil producer cartel OPEC to not cut production – has meant that prices have not had any support.


An illuminated Grangemouth Oil Refinery emits smoke on March 29, 2012 in Grangemouth, Scotland.
Jeff J Mitchell/Getty Images
An illuminated Grangemouth Oil Refinery emits smoke on March 29, 2012 in Grangemouth, Scotland.

Various other factors have continued to weigh on prices including unseasonably mild weather dampening demand, rampant production amid a hefty build in crude stockpiles and geopolitical tensions. But the latest dent to market confidence came from China where market turmoil prompted skittishness in oil markets, already concerned over slowing China demand and increasing instability.

Oil market analysts were left pondering how much further oil prices could plunge on renewed market and geopolitical instability but weren't keen to put a price on the drop.

"I wouldn't put a number to it as it's like throwing a dice on a board," Miswin Mahesh, oil market analyst at Barclays told CNBC Thursday. "Our forecast is for prices to see an improvement in the second quarter. The current prices are not sustainable but it will get worse before it gets better – and we're in the process of that," Mahesh noted.

Oil costs less than beer?

If China volatility wasn't enough, geopolitical turmoil was also weighing on markets as a row between major oil producers Saudi Arabia and Iran, whose supply is due to come back following the repeal of international sanctions following a nuclear deal, flared up this week.

Although the row could have been positive for oil markets, meaning that there could be some kind of agreement between the two OPEC members over oil output levels, Mihesh warned against misplaced optimism.

"At first, people thought that the row was a positive for oil markets, there was a glimmer of hope that Saudi Arabia wouldn't ramp up production (as Iranian production returned) but now that hope has disappeared."

On a price note, Mahesh said even if oil prices declined much further, Saudi Arabia would not change its strategy of maintaining record production levels as it tries to pressure rival producers, such as shale oil producers in the U.S. and Canada, who have higher production costs, out of the market.

He noted that as Canadian oil dropped below $20 a barrel, (Canadian oil producers have a breakeven price of $40) a pint of beer actually cost more than an equivalent amount of oil currently.

Inventories

No small part of the depression of oil prices on Wednesday was due to the latest data pointing to a continuing build in inventories – particularly gasoline. Data from the U.S. Energy Information Administration (EIA) showed that the U.S. added 10.1 million barrels of gasoline, the Energy Information Administration said. It added 900,000 the week before.

Although U.S. crude inventories dropped by 5.1 million barrels last week, markets treated the data as bearish as oil prices fell 5 percent on Wednesday. After all, the IEA noted in its weekly petroleum report that, at 482.3 million barrels, U.S. crude oil inventories "remain near levels not seen for this time of year at least in the last 80 years."

Until those "hefty" inventories begin to clear, oil prices will remain subdued, oil analyst Dominic Haywood from Energy Aspects told CNBC on Thursday, explaining the various factors adding to oil's woes.

"Markets are still heavily oversupplied, the weather is much warmer and there is pretty heft overhang in inventories and prices won't be able to rise until that's cleared," he said. "How low will prices go? Well, it just becomes a number now, prices could go as low as the lifting costs (the cost of producing oil and gas after drilling is complete) for producers, around $2 to $5 a barrel, but that's not realistic."

Energy Aspects believed that prices would start to improve in the second half of the year when there would be "more aggressive production declines" with Haywood noting that the firm estimated a year-on-year decline of 250,000 barrels a day from U.S. producers.

"First of all, we need production to decrease but it needs to adjust lower for quite a long time. Then we need the overhang in inventories to clear before we see a price increase. If we can clear that, we could see prices average $60 in 2016 and higher in 2017."

- By CNBC's Holly Ellyatt, follow her on Twitter @HollyEllyatt.