Investopedia/Gary Ashton: Is Oil Forever Stuck at $40 to $60 Per Barrel?

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Is Oil Forever Stuck at $40 to $60 Per Barrel?

By Gary Ashton | November 20, 2016 — 6:33 PM EST
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As the market awaits the results of the OPEC meeting at the end of the month, many analysts are increasingly convinced that the result of the meeting is actually meaningless because oil is destined to remain in a trading range of $40 to $60 per barrel forever.
What Happens at $60 Per Barrel

If oil prices ever do get to $60, many economists and analysts feel this is the magic number where U.S. shale oil production comes back on line, which would act as a demand ceiling for oil prices. For example, Reuters reports that Fatih Birol, the head of the International Energy Agency (IEA) said, “U.S. shale oil producers will increase their output if oil prices hit $60 a barrel.” This is the price where producers that currently have production “shut-in” would be willing to re-start idle drilling rigs. It is also an attractive price to hedge the price to ensure operations can be maintained in the event of another price dip.
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What Happens at $40 Per Barrel

Most of the world’s major oil producers like Russia and Saudi Arabia need oil to be at least $40 per barrel for their federal budgets to balance. So when oil prices start to drop, these producers start making statements about limiting output and curbing supply. The result is that short-sellers of oil are forced to close their positions, and prices find a floor. (See also: U.S. Oil Defaults Up Despite Stable Oil Price.)

So far, it seems to be working. Bloomberg reports that Russia has made $6 billion by talking to OPEC: “Russia’s decision earlier this year to engage in talks with OPEC about limiting oil output has added more than 400 billion rubles ($6 billion) to the nation’s budget, according to two officials familiar with government calculations."
What Will It Take For a Breakout

Will oil, in fact, stay in a range of $40 to $60 forever? Eventually, something in the market will take it higher or lower. The IEA knows this too. Reuters reports that the IEA chief said in an interview that, "we are entering a period of greater oil price volatility and the companies, organizations and countries should prepare themselves accordingly.” Tighter oil supply and price spikes in the future are increasingly possible because of the investment slowdown in new oil development. If we get a supply or demand shock, that would likely push prices out of the $40-60 range.

Disclaimer: Gary Ashton is an oil and gas financial consultant who writes for Investopedia. The observations he makes are his own and are not intended as investment advice.

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