With oil hovering around the $30 mark, many are starting to call for a complete collapse of the industry via predictions of another 50% drop in prices to $15. Yeah, that’s not going to happen – outside of the impossibility that every private operator and NOC (National Oil Company) will somehow max out production volumes with complete disregard pricing. Even then, would it really fall to $15 dollars? Lots of bankruptcies before we get there. The bottom line is that the wild down in oil markets is poised to follow an equally wild ride back up, potentially to record levels.

Is that capitulation i see?

A colleague of mine called my attention to a news report that gas was selling for $0.47 at a station in Michigan – I can’t even remember the last time it was that low! I mean it was like $0.90 in or around ’89, but that price just seems insane! Well it is – a local station owner is looking to take a page out of the Saudi’s books and attempt to gain more market share by pricing out his competitors. Breaking even on the retail side I guess? May not have been the best strategy long term, as I seriously doubt the guy has Saudi-like cash reserves to burn.

Adding to the absolute insanity in prices paid by consumers, we also find ourselves staring at absolutely monstrous short positions in oil futures. 1500 March $17 puts were sold at a price of $0.04. Sounds like it’s nothing, but somebody is actually putting $60,000 on the line for the remote possibility that Oil would go below $17/bbl in the next 30 days. It starts to get crazier from here. Open interest for the March $25 put options represents about 21.4MM barrels of oil being wagered to fall below $25 in the next 30 days. At Friday’s close, the right to short those 21.4MM barrels would cost over $10,000,000. That’s just insane!

Why will go up and where will it go?

This is an easy one, likely why its being overlooked by #MSM. The Saudi-Iran standoff can only end with two eventualities: 1) all out war disrupting over 10MM bbl/day, or 2) they work something out to avert mutual destruction. Sanctions dropped oil production in Iran significantly:

Iran Oil production - 10 year historic

Going back to pre-sanction production levels, however, will not recover losses associated with a over 70% decline in commodity prices. The Saudi’s are facing the same issue – demand needs to outpace production in order for prices to recover. Neither country can stand this level of revenue loss long term, especially Saudi Arabia as they are dealing with internal dissent from their populous, in-fighting between members of the royal family and a growing sense that the United States is no longer the ally they had once known (now more vulnerable to external forces). Yemen and Syria may just be the tip of the iceberg.

This is a major reason that I’m calling for a return to more reasonable price levels in the months ahead. There is no in between for the two mid-east powers, as inaction is assured mutual destruction. I’m not alone in this regard, as others are calling for oil prices to skyrocket to $250 or more.

It’s not just the geo-political issues, but the world will continue to grow and demand more energy, regardless of where we are at in the business cycle. The latest report published by the EIA has adjusted 2016 demand growth to only 1.2MM bbl/day. That’s right, per day – the previous forecast was 2.2MM bbl/day.

Looking at current global production levels and forecasted demand, 2017 forward is setting up nicely for a full oil recovery:

World oil demand chart through end of 2015

world oil production chart through end of 2015

I just don’t think there is any way Iran and Saudi Arabia can wait it out for a year until fundamentals fully adjust in their favor – the monarchy might not be around by then.

Oh, and there’s also ISIS – they just lit up oil fields in Libya, which are visible from space (NASA published the photos).

The final word 

I think we will see prices head back towards $40 in the next 30 days.