Energy Outlook For 2014: Bearish On Oil Prices?

Market analysts have been pairing back their forecasts for both Brent and West Texas Intermediate crude as “rampant” increases in US shale resources look set to create a glut. The US shale revolution is showing no signs of slowing with US oil production forecast to increase by 1 million barrels a day in 2014. Deutsche Bank recently cut their 2014 forecast for Brent to $97.50 a barrel, from $106.25, and its estimate for WTI to $88.75 per barrel, from $97.75.

Crude oil closed out 2013 on a rather bearish note due to supply abundance, with Brent crude finishing at $110.80 and WTI closing at $98.40. The two main drivers for lower oil prices were: strong oil production – especially from the US shale boom, and weak global oil demand growth of just 1%.

US oil inventories ballooned last year, which in turn suppressed WTI to its sub-$95 handle at the end of 2013. US crude oil production grew at 20.4% yoy while crude imports contracted 9.9% yoy in 2013. This resulted in inventories rising by 3.2% over the same period, amounting to 361 million barrels versus the 5-year average of 349 million. US shale production is likely to outpace oil producing OPEC (Organisation of Petroleum Exporting Countries), except Saudi Arabia, over the next two years according to Exxon Mobil. Given the supply abundance, the US is likely to become increasingly less dependent on oil imports which will in turn support the US economy and the USD. It is worth noting here that over the past decade the dollar has usually weakened whenever the price of crude rises. That inverse relationship broke down in December according to data compiled by Bloomberg. The 120 day correlation between the two assets which has averaged -0.3 over the past ten years, turned positive at the end of 2013 before reaching 0.033, which was the highest positive relationship since 2003. This makes sense as there are currently fewer dollars being spent on crude imports and thus the USD is less exposed to rising crude prices.

The biggest challenges facing US shale production are technical issues pertaining to shale hydraulic fracturing (fracking), safety, and environmental issues.

Further, it would be imprudent to discuss the outlook for oil without referring to potential geopolitical issues. Historically, oil prices have been extremely sensitive to geopolitical tensions, especially those originating in the Middle East. Sustained supply side disruptions could cause the price of oil to spike by anywhere up to $50/bbl. During 2013, tensions in Syria, Libya and Iran squeezed the price of Brent crude sending it above $110/bbl. Many of these issues have since defused but geopolitical risks remain to be a wildcard in 2014.

In summary, given the expected supply side abundance and stabilising geopolitical conditions in the Middle East, it is difficult to be anything but bearish on oil prices in 2013. Barring significant production hiccups or geopolitical escalations, it is plausible that WTI and Brent will fall sub $90 and $100 respectively by end-2014.