The oil price entered a bear market this week, as West Texas Intermediate Crude slipped below $40 a barrel for the first time in more than three months and higher-than-expected output weighed on investor fears of a continuing global glut. Brent crude, the more widely used international benchmark, also dipped below $42 a barrel, having passed the $54 mark at the beginning of June.
The price falls came despite concerns around the weakness of the dollar - normally a positive signal for energy prices - and data from the American Petrol Institute that suggested the country's oil stockpiles were falling in line with expectations. But while market commentators, including the International Energy Agency (IEA), have spent much of this year predicting a rebalancing of supply and demand in the third fiscal quarter, a firmer recovery in prices still looks a long way off.
This pessimism was underlined by BP's (BP.) recent half-year results, in which the group reiterated its intention to reset operations for a $50-$55 per barrel oil price range. The fact BP's break-even target was $60 as recently as February is telling.
So what are the broad arguments behind oil's potential trajectories given the assumption of a smooth return to higher prices is under pressure?
The bull case
Global economic growth expectations may have been knocked in the past year, but growing demand for energy from emerging markets is not going away. The shake-out witnessed in the past two years has left swathes of future production abandoned, and the largest companies fundamentally nervous or incapable of high-volume capital-intensive projects. Specifically, the global rig count has more than halved in response to a 3 per cent supply glut, and even if US shale swing producers return to the wellhead if prices improve, the shorter lifespans of fracking wells make them a more volatile supply source. Put simply, the low oil prices seen so far this year and last will have discouraged an enormous amount of investment, and will inevitably lead to a sharp increase in prices. That could happen the moment that market demand catches up.
WTI versus Brent Crude futures contracts
The bear case
Despite some supply disruption in Nigeria, Kuwait, Venezuela and Canada, there were no physical shortages of product amid the oil rally between February and June. According to petrochemicals consultant Paul Hodges, this suggests there was never any fundamental reason for prices to rise. "Instead," he argues, "prices once again rose because financial players expected the dollar to decline… realised this meant they could make money by buying oil on the futures market as a store of value… [and] now as the dollar has started to recover, they are selling off these positions."
Aside from alleged financial manipulation, some believe the diminished authority of Opec may effectively guarantee a prolonged glut in supply. If Saudi Arabia's deputy crown prince, Mohammed bin Salman, can assert the country does not care about oil prices, as he did in April, there seems little indication the cartel will rein in overproduction.
The midpoint
The IEA sounded a note of caution last month when it stated that despite "regular upwards revisions to demand, there are signs that momentum is easing and although stocks are close to topping out, they are at such elevated levels… that they remain a major dampener on oil prices". The unwinding in the huge build-up in US inventory levels will therefore take a while, but at the current unprofitable prices they are unsustainable. Ian Taylor, chief executive of oil trader Vitol, does not expect prices to rise beyond $50 this year, but thinks low-cost unconventional producers mean the market needs to get used to a long-term range of $40-$60 a barrel.
