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Oil Market Outlook 2016

Part 1: The Crude Flood Cometh... and Taketh

Written by Keith Kohl
Posted November 24, 2015

What's ahead for the oil market in 2016: rally or ruin?

Unfortunately, the answer to that question isn't as easy as you might think.

Had you asked me a year ago, I wouldn't have given it a second thought before telling you that it's simply a matter of when production destruction would take place.

After all, the cure for low oil prices is low oil prices.

However, the problem is that even after 18 months of falling oil prices, we're only now starting to see U.S. oil output decline. Most analysts were expecting to see this decline sooner.

Better late than never, right?

Production Destruction

No matter what the doom-and-gloom crowd cooks up, a recovery is inevitable — that's just the nature of the boom and bust cycle of the oil industry.

It's not a difficult concept: Oversupply leads to low oil prices, which causes a drop in investment and drilling activity, which in turn tightens the supply-demand equation and pushes crude prices higher, spurring investment once again.

However, there are a few problems to keep in mind...

First and foremost, today's oil supply just isn't the same. Roughly 54% of oil output in the United States comes from one of six tight oil plays. You should be able to guess the big three plays immediately: the Bakken, the Eagle Ford, and the Permian Basin.

Nearly five out of every 10 barrels extracted within the United States comes from those three plays.

And for the first time since oil prices started crashing in June of 2014, we're finally starting to see production stagger... so how far will production fall, you ask?

In the EIA's latest Short-Term Energy Outlook, it projects U.S. oil production to average 9.3 million barrels per day in 2015, then decline by 5.3% next year, averaging 8.8 million barrels per day in 2016.

In fact, the EIA is expecting a sharp decline in December 2015, when total output is projected to fall 118,000 bbls/d — the largest monthly decline on record!

Of course, the only area I believe we'll see any growth in is the Permian Basin, where operators have been resilient this year. Then again, the boom-and-bust nature of the oil market is well known in West Texas.

That's a good sign, believe it or not.

From a price standpoint, don't expect triple-digit crude oil anytime soon. The EIA's forecast projects a slight 2.8% increase in the price of WTI and a 4.5% increase in the price of Brent crude in 2016:

chart2prices1123eac

Remember, the United States' crude oil inventory is still at record levels, far above the five-year average. That glut will have to ease before any prolonged price rally takes place.

According to the International Energy Agency's November Oil Market Report, global supplies reached 97 million barrels per day in October, thanks to non-OPEC output.

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Moreover, OECD commercial inventories of crude oil hit record levels of approximately 3 billion barrels by October 2015.

And there's one factor we certainly can't forget about: OPEC.

The OPEC Interlude

It's no surprise that despite the rise of tight oil output in North America, OPEC is still a powerhouse of the global oil industry.

Together, the 12-member oil cartel pumped an average of 31.76 million barrels per day in October of 2015, accounting for roughly one-third of the world's oil supply.

Of course, the Saudis have been waging a full-fledged price war for the last 15 months, hoping to both retain their share of the market and drive the tight oil operators out of business.

Unfortunately, the Saudis have more to worry about than the U.S. shale boom. King Salman and the House of Saud also have to contend with a flood of supply from within the ranks of OPEC.

Keep in mind that the U.S. and Iraq have been to the two largest contributors to global supply growth. Now, I just mentioned that U.S. output is poised to decline next year, but thanks to a prolonged period of low oil prices, Iraq's output is expected to remain flat, with crude under $50 per barrel.

Meanwhile, Iran is expected to begin exporting up to 500,000 bbls/d any day now. And any penetration into the Asian oil market will take a sizable bite out of Saudi Arabia's market share.

In other words, the Saudis are fighting an oil war on two fronts.

Next week, OPEC will make a pivotal decision as members get together to set production targets. And for the first time in a year and a half, the Saudis are hinting that they're finally ready to stabilize crude prices.

Stay tuned, because supply is only half of the equation. We'll cover the demand side next week, then take things a step further and delve into which investments stand to turn a tidy profit for you in 2016.

Until next time,

Keith Kohl Signature

Keith Kohl

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A true insider in the energy markets, Keith is one of few financial reporters to have visited the Alberta oil sands. His research has helped thousands of investors capitalize from the rapidly changing face of energy. Keith connects with hundreds of thousands of readers as the Managing Editor of Energy & Capital as well as Investment Director of Angel Publishing's Energy Investor. For years, Keith has been providing in-depth coverage of the Bakken, the Haynesville Shale, and the Marcellus natural gas formations — all ahead of the mainstream media. For more on Keith, go to his editor's page.

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