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Oil could drop into the $20s

Crude-oil prices have gotten slammed over the past month, and the market bears have not even gone in for the kill, yet. WTI oil prices look like they could trade down to at least the low $30 area, and a trip down to the mid-$20s cannot be ruled out.

The market is experiencing a classic bear-market syndrome where good or supportive news gets ignored and bearish market elements get seized upon.

Up until recently, the oil-price decline was primarily driven by surging supplies from all corners of the world. Every major producer that has been able to up production has done just that, with several hitting record output levels, such as Saudi ArabiaRussia and Iraq. And where would prices be if Iran had not been held back by sanctions and Libya was stable?

Just this week, a report showed Saudi Arabia’s June production and exports climbed even higher.

The downside story has gotten reinforced by a new element of shaky demand due to worries over the key Asian economies of China and Japan. China’s economy has been slowing, and it has taken a big hit recently — real or imagined — from the crash of its Shanghai stock market. Japan posted a negative gross domestic product reading for the most recent quarter, ending hopes of a sustained economic rebound emanating from the massive central bank easing measures there.

Oil-market bulls had clung to rising demand as a source of hope, and, in the U.S., motorists have hit the road in a big way, celebrating low pump prices (save for California). But even that phenomenon is set to ebb with the conclusion of the summer peak driving season. Diesel fuel demand, in contrast, has been mostly lower all year.

So, what’s next?

There appears to be more downside for sure.

There has been a significant increase in refining capacity by Saudi Arabia and China, which is in the process of creating a global diesel fuel glut, which will likely enable the next leg lower for prices this fall.

Crude oil is a dollar-denominated commodity, so expected U.S. dollar strength from the looming Federal Reserve interest-rate tightening cycle, will add to the downward pressure.

The unrelenting production from the global major oil producers shows no signs of abating for now, either.

Will the worm ever turn?

Yes, this is a commodity market, after all, and oil is a classic boom-and-bust industry.

One key to watch is U.S. oil production, which hit a high of 9.6 million barrels per day, earlier in the year, but has finally begun to come down, thanks, in part, to the greatly reduced drilling-rig count and financial stress in the industry. The U.S. exploration and production industry will likely get ravaged this fall by bankruptcies and consolidations.

If U.S. oil output falls below 9.0 million barrels per day in early 2016, as I expect, that may be enough to induce Saudi Arabia and others within OPEC to reduce their production levels. Such a move would trigger a price rebound to at least the $60 level. The market will quickly reward a production cut by Saudi Arabia and others within OPEC.

Still, the production dynamic will continue to evolve. A price rebound will cause a lot of currently sidelined or deferred U.S. production to be brought into service, making for a volatile year.

New multi-year lows will continue to be made for WTI oil prices, and this will be the fall of the industry’s discontent. While $30 seems like a reasonable low price point, I am staying wide open to the possibility that much lower prices could ensue, if the world’s oil producers stick to their guns and the U.S. shale riders somehow hang on through it all.


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