Oil is heading toward another crash

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$20? CLSA

Some analysts are betting that the recent jump in oil prices will be short-lived.

A big meeting of producers in Doha, Qatar last Sunday ended without an agreement to cap output.

Christopher Wood, author of CLSA’s weekly GREED & fear letter, said Thursday that this proves oil will drop to $20 a barrel — one of the most bearish calls out there.

West Texas Intermediate crude, the US benchmark, traded as high as $44.45 a barrel Friday. Brent crude, the international benchmark, rose to $45.89.

To recap Doha, members of the oil cartel OPEC and nonmembers met to try and agree on output ceilings in an effort to help lift prices. Many economies, including OPEC’s de facto leader Saudi Arabia, have been strained by the price collapse.

But Iran — Saudi Arabia’s geopolitical rival — has an opposite agenda. It is increasing production to start exporting again, now that economic sanctions have been lifted.

The Saudis refused to sign an agreement without Iran, and so the meeting flopped. That sent oil prices lower by 5% in futures trading last Sunday.

But by Friday, US oil was headed for an 11% weekly gain. Wood said in his note that he finds the rally baffling:

GREED & fear also has no claim to be an energy expert. Still GREED & fear remains highly sceptical of this sanguine view on oil with the base case here that oil will re-visit the US$20 level, sooner or later, in the absence of an effective OPEC instigated production freeze.

Oil-price moves over the few weeks leading up to Doha had been dominated by speculation about the meeting of oil producers that took place last Sunday.

Now Wood also noted that last week’s rally was aided by production interruptions in Kuwait, where oil workers went on strike after a disagreement with the government over planned pay cuts.


Also, US oil production fell for a sixth straight week, after a big run-up that contributed to the price plunge. That raised bets for higher prices in the futures market.

Still, why would anyone be bearish?

“The fact that oil has not sold off has also encouraged those who believe that oil has bottomed on the view that the industry has started to adjust,” Wood said.

The rise in prices since Doha is further encouraging this view, which is wrong, according to Wood.

He’s maintaining the $20 forecast because everything about shale fracking suggests that oil drilling will be more productive, meaning an even bigger glut.

And then, we’d also consider comments from Schlumberger, America’s largest oil driller, in its first-quarter earnings on Friday.

Global spending on oil drilling “is expected to continue deteriorating over the coming quarter given the magnitude and erratic nature of the disruptions in activity,” CEO Paal Kibsgaard said. On its part, Schlumberger will focus on cutting costs and staying profitable.

Meanwhile, global oil inventories remain at historically high levels, and near 100% of storage capacity in some areas. Wood does not think the official data captures all that’s really in storage.

Wood said that ultimately, the efficiency of shale technology should keep the US as the swing producer, not OPEC or Saudi Arabia, as it used to be.

“Doha confirms we are now in the new normal,” wrote Citi Research’s Farouk Soussa in a recent note to clients.

He argued that the oil crash, which has prices 60% below their peak two years ago, can no longer be dismissed as a blip. That’s because the Doha outcome proved that global oil producers will struggle to curtail their supply in the longer term.

And so while not everyone is betting on a drop to $20 — about half of Friday’s price — there are healthy doubts about how much higher oil can go.

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