Sunday, December 28, 2014

Question #7 for 2015: What about oil prices in 2015?

by Bill McBride on 12/28/2014 06:29:00 PM

Earlier I posted some questions for next year: Ten Economic Questions for 2015. I'll try to add some thoughts, and maybe some predictions for each question.

Here is a review of the Ten Economic Questions for 2014.

7) Oil Prices: Declining oil prices and falling bond yields were two of the biggest stories of 2014. Will oil prices continue to decline in 2015?

The reason prices have fallen sharply is supply and demand. It is important to remember that the short term supply and demand curves for oil are very steep. 

In the long run, supply and demand will adjust to price changes.  But if someone asks why prices have fallen so sharply recently, the answer is "supply and demand" and that the short term supply and demand curves are steep for oil.

The keys on the short term demand side have been the ongoing weakness in Europe and the slowdown in China.   Professor Hamilton estimates that about 45% of the recent decline in oil prices was due to weakness in the global economy. Will Europe recovery in 2015? Will China's growth increase? Right now it looks like more of the same, so I expect the demand side to stay weak in 2015.

For supply, some of the increase has been due to increased shipments from Libya, but most of the supply increase has been due to increased tight oil production.  The questions on the supply side are: 1) will be there be a 2015 supply disruption in Libya, Iraq, Nigeria, or some other oil exporting country, and 2) what price will lead to less fracking production?

Professor Hamilton posted some thoughts today: Supply, demand and the price of oil

At what price would supply and demand be back in balance? I won’t even make an attempt to predict short-run developments for the wild cards like Libya, Iraq, and China. But in principle, the U.S. supply situation should be simpler. At current prices, some of the higher-cost producers will be forced out. It should be a textbook problem of finding the point on the marginal cost curve at which there’s an incentive for the marginal producer to meet desired demand; given a quantity Q demanded on the horizontal axis, find the price P associated with that Q from the height of the vertical axis on the marginal cost curve. The problem is, nobody knows for sure exactly what that marginal cost curve looks like, and sunk costs for existing wells make it hard (and painful for the oil producers) to find out.
It is impossible to predict an international supply disruption - if a significant disruption happens, then prices will obviously move higher. Continued weakness in Europe and China does seem likely - and I expect the frackers to slow down with exploration and drilling, but to continue to produce at most existing wells at current prices (WTI at $55 per barrel). This suggests in the short run (2015) that prices will stay well below $100 per barrel (perhaps in the $50 to $75 range) - and that is a positive for the US economy (Note: the US is a large importer of oil - see: Katie Couric and the Net Petroleum Exporter Myth

Here are the ten questions for 2015 and a few predictions:
Question #2 for 2015: How many payroll jobs will be added in 2015?
Question #3 for 2015: What will the unemployment rate be in December 2015?
Question #4 for 2015: Will too much inflation be a concern in 2015?
Question #5 for 2015: Will the Fed raise rates in 2015? If so, when?
Question #6 for 2015: Will real wages increase in 2015?
Question #7 for 2015: What about oil prices in 2015?
Question #8 for 2015: How much will Residential Investment increase?
Question #9 for 2015: What will happen with house prices in 2015?
Question #10 for 2015: How much will housing inventory increase in 2015?