Oil Gets Slammed: Will $2 Gas and Cheap Flights Return?

2 dollar gas

For those of you on the West coast, my sincerest apologies! The rest of us are paying not only much lower income taxes and fees but a dollar less per gallon at the pump. Our St Louis stations are now back under $2.50 a gallon and rural parts near $2.20, while the lowest areas in the nation are already testing $2/gallon for regular gasoline at the pump. If it makes “Left Coasters” feel any better, Alaska seems to have the highest average cost for gas, however they have no state sales or income taxes!

We believe it’s likely sub $2 gasoline will return for most of the nation outside of the West Coast by year end. The reason has been in our forecasts for a long time and it’s simple: Supply is rising faster than demand. 

gas price average

Not only are gasoline prices down by a third since last year but jet fuel costs for airlines are lower by nearly 50% !!! and down about 60% from peak to trough since 2013. Politicians have not wasted anytime calling for collusion and price gouging investigations. Airline profits are “soaring” to record levels and it may still be a good time to buy airline stocks vs airline tickets. While there certainly are some oligopolistic powers at work and stickiness in lowering fares, critics must also keep in mind that airlines historically have lost money hand over fist and have “rarely” experienced extended operating cost reductions such as we are seeing in 2015.

jet fuel costs

“If” jet fuel prices remain depressed through year end and into 2016 we suspect that ticket prices will continue to edge lower and not because they are being investigated.

air ticket cost forecast

Our learned professors taught us that when prices rise the prodcution increases until it exceeds demand which leads to competitive price reductions and lower supply until consumption demands create scarcity for the next cycle of inflation. We noted last year that history has shown analysts and professors to be a bit myopic when reviewing the example of Natural Gas which crashed in 2008 and prices have remained in a depressed Bear market. Despite 80% of Natural Gas rigs being shut down for almost 7 years, supplies increased, much the reverse of what was expected. Failing to learn from the past, T.Boone Pickens and professional managers again called for Oil rigs to be shut down in 2014/2015 as prices crashed from $112 to $43 a barrel, yet as Exec Spec forecasted, Oil production has continued higher with surging inventories far above normal. 

Did Saudi Arabia drive down oil prices?

NO!!! As we have said many times over the past year the claim of the Saudi’s engineering an oil price drop to drive out high cost US shale producers/frackers to regain control over the oil market is ludicrous on many levels. With the most extreme group of radical Al Qaeda Sunni citizens in their midst and 80% of their budget funded by Oil, do we really think the Saudi’s would be willing to orchestrate (if they could) a whopping “”50%”” cut in their Government budget? Are they happy to send prices into the $20’s with an 80%+ revenue cuts as the Saudi’s have claimed if needed to drive out marginal producers in the US? For how long do you think they could afford such a policy with “The Barbarians at the Gate”?

The FACT is the Saudi’s and naive analysts talk their book, while reality can be seen here. After oil prices surged from 2009 into 2013 the Saudi’s “increased” their output with prices and maintained elevated supplies before and after oil prices peaked in June 2014. If the Saudi’s wanted to kill US producers they should have kept production low after prices collapsed, yet they boosted production to record levels! Why? Because they needed the cash. They are not smart enough to know how low and how long prices need to stay weak to drive out the competition. They also can’t predict just how fast the competition will come back when prices finally rise again. We are quite confident that the Saudi’s had very little to do with the one year collapse in Oil prices. They would have to be willing to risk sharply lower budget revenues and economic despair for years to come potentially and most importantly risk the delicate uber wealthy dictatorship they possess.

Saudi Arabia Crude Oil Production

Certainly the fallacy of any corrupt bargain manipulating oil prices can be seen as fallacious or at least callow by observing the reaction of natural gas post 2008 and here with oil in 2014/2015. Despite more than 50% of North American land based Oil rigs being shut down, production has increased and prices continue to threaten new lows. As usual the majority of production is concentrated in a minority of oil rigs which have sunk costs and will produce at very low operating costs. $30 or $20 Oil:  there will be a price where production will slow, but remember that most producers are in it for political reasons and must “increase” production as prices fall for the time being.  Russia and OPEC need the cash flow, even if they lose money. As soon as prices rise you can also bet that rig counts and production will inflate.

United States Crude Oil Production

The excess supply over expected future demand that triggered the energy price drop in July 2014 finally resulted in surging inventories in 2015 (see below). One of the reasons we haven’t seen an even sharper fall at the gas pump however is that refiners needed to secure higher profit margins before they slowly begin to trust that lower prices are here to stay. Winter fuel additives will cause a seasonal 10 to 15 cent price drop at the pump by September and refiners will likely induce further price cuts at the pump before year end as we approach $2 once again.

oil storage

Oil companies enjoy rising prices while refiners tend to lose margins until prices stabilize or fall. Refiners converting oil into distillates and unleaded gasoline were not making consistent profits for about 7 years until the past few months. Like the airlines, we should expect the extended deflation of raw material inputs to translate into lower consumer energy prices eventually.

refinery profits

 

Like our long term Gold forecasts for the $1,100’s and potential for sub-$1,000 an ounce, we have also discussed the potential for Oil in the $30’s and $40’s. To even our surprise the global economy seems to be weakening in 2015 instead of inflating after 6 years of massive monetary stimulus and historically cheap producer prices. With 50 to 60% cheaper Oil gifting the world an enormous tax cut along with artificially suppressed borrowing rates and massive fiscal and monetary handouts, one would eventually expect above trend economic growth and above normal rates of inflation. Yet the emerging markets and China appear to be slowing further in 2015 and the 1st world Western economies continue to suffer from long term demographic and debt hangovers that have resulted in less responsive business and consumer consumption habits to the historically attractive environment that has evolved. This should extend this slow growth economic up cycle since 2009.

Our long term chart below illustrates the broad target zone we expected for the maximum downside prices in oil before a longer term bottom could develop. Futures contracts are already testing new lifetime lows while our long term support zone remains in the low $30’s to low $40’s.

Oil monthly

The daily oil price chart here (below) shows the seasonal rally we said to expect in the February to May time frame. While August and September can also be a very strong period for energy prices, we would favor a reaction much the same as 2014 when seasonal trends were overwhelmed by macro trends of sluggish future demand and rising oil inventories. Refiners need to start drawing down the extreme bulge in oil inventories and sending the byproducts such as gasoline, diesel and heating oil to the marketplace. The August to October time frame when winter mixes change may be an opportune time for refiners to begin converting refined products faster. we forecasted that prices were in a Bear market and would deflate once again after the seasonal spring bounce. Like 2014 Oil prices peaked in June in the $60’s ($112 in 2014) and have fallen sharply in July. One of the clues we had for the 2014 and 2015 oil price drops were the sharp negative divergences in junk bonds vs oil. Junk Bonds can portend risk for our stock market as well when collapsing, but they seem to reveal underlying stress in the energy markets as defaults rise. 

Oil daily July

We would note the very sharp December 2014 drop in Junk Bonds signaled trouble for our stock market that month, but also the negative Junk price divergence with oil can give some warning of the downward pricing pressure in energy markets.

junk bonds vs oil

Harry Dent provided an important awareness of demographic trends in the US and around the world and how they could influence many different markets. His basic “premise” has proven valid from our perch in expecting 1st world consumption rates and euphoria to peak in the 2005 to 2010 period with an ensuing sluggishness to persist until the early 2020’s. Central Bank monetary forces and Governmental ability to maintain adequate levels of confidence have disappointed Dent’s many calls since 2008 for a full bore Depression (think 1930’s), in our opinion. Nonetheless, the past 7 years of stimulus has yet to achieve the normal “liftoff” for a normal economic glide path. Commodity prices remain in a long term Bear market and Oil prices are just another key product that is behaving as it should when expected future supply exceeds expected future demand. One last negative to add to the Oil mix: future production may actually increase even if US supply stop growing. Not only will Iran most definitely be sending additional supplies onto the global marketplace due to Obama’s “Treaty” – (or “Agreement”), but the amazing US innovation of fracking will soon spread to new fields such as Brazil, Bolivia and Argentina.  Without a surprising surge in the global economy, which isn’t on the view-able horizon, energy prices should move even lower before a long term bottom takes shape!

 

 

 

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