The oil crash has been one of the most important investment themes of 2014 and 2015. The price of West Texas Intermediate – WTI – crude oil is currently sitting just above $53. Current prices are more than 50% lower than the June 2014 high of $107 and, believe it or not, oil prices have actually rebounded in the past few weeks since January lows around $45 per barrel.
Citigroup (NYSE: C) just lowered its forecasts for the oil market, predicting that oil could fall as low as $20 per barrel. Goldman Sachs (NYSE: GS) recently came out with its own forecast, predicting that oil would fall to $39 per barrel.
If true, these forecasts mean that the oil crash is far from over. I decided to take a closer look at several key metrics that tell us a lot about the oil market. What I found is certainly concerning if you own any stocks that are connected to the oil market.
One of the primary drivers of the current oil crash is the huge surge in oil production that has taken place right here in the U.S. The chart below illustrates this rapid increase in production, showing that in just the last three years we have reclaimed 1974 levels and erased decades of production declines.
One of the most important oil metrics that I track is the number of active rigs in the U.S. This data comes from Baker Hughes (NYSE: BHI), which releases updated rig count weekly. The chart below includes the data released this past Friday.
Baker Hughes claims that in a typical down cycle for oil the number of active rigs will drop between 40% and 60% from the peak. I’ve drawn both of these levels on the chart below to illustrate how much further the number of active rigs will need to fall to reach the Baker Hughes forecast for rigs removed from operation.
As you can see, the number of active rigs has been dropping sharply in 2015 but has considerably further to fall if Baker Hughes’ estimate of a 40%-to-60% decline comes true. Considering that just about every oil and natural gas producer has announced cost-cutting measures between 30% and 60%, the steep decline in active rigs should come as no surprise.
What might surprise you, however, is this next chart.
The chart below illustrates oil inventory levels, which currently sit at 80-year highs.
What this tells me is that, so far, the steep decline in the number of active rigs has done nothing to slow the oversupply issues – at least not yet.
This is exactly as Goldman Sachs is expecting for the oil market.
“The rig count decline is still not sufficient, in our view, to achieve the slowdown in U.S. production growth required to balance the oil market,” analyst Damien Courvalin informed Goldman clients last week. He went on to add that Goldman reiterates its “view that oil prices need to remain lower in the coming quarters in order for the announced capex guidance and rig reduction to materialize into sufficiently lower production growth.”
What this means is that the oil crash isn’t over yet. It will take time to see the effects of spending reductions announced by all of the major oil producers, for the oversupply of oil to settle out, and for the production capacity of the U.S. oil and natural gas industry to reach sustainable levels.
Saudi Arabia’s Plot Backfires!
When the Saudis announced they would not cut production to bolster oil prices, the intent was obvious. The move was meant to drive down crude prices, and punish the U.S. oil industry. The US had already over taken both Saudi Arabia and Russia in crude production – and the Arabs thought they could stop it with this move. WRONG! And we’ve found a great way for the average guy to cash in.