When OPEC cuts output, oil prices will begin to climb 

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While the consensus view is the the oil price will go even lower yet, once production is reduced it will start rising again.

There’s a very good reason why the price of oil keeps falling – there’s no real need to buy it. For now.

Until the Organisation of the Petroleum Exporting Countries unwinds its current policy of flooding the market with supply, in an attempt to squeeze everybody else out, the price of oil will remain under pressure.

Hedge funds will either stick with their current short positions or keep adding to them, emboldened by the fears of deflation – which is also helping to push down bond yields – and a slowdown in China that all feeds neatly into their grand trade.

For the time being traders will look at the latest numbers from China – which show demand for oil fell almost 5 per cent in November, the first decline since mid-2014 – and will be tempted to stay short.

Selling is definitely in vogue but for any trade to make money it has to be closed out at some stage.

Barclays says the oil, gold and copper markets are now pricing in the worst set of conditions since 1983, while short positions in all commodities is 10 times what it was during the depths of the 2008-09 global financial crisis.

If it’s best to buy when everyone else is selling, perhaps Santos at about $3 is beginning to look like a bargain. The same could be said for BHP Billiton at $14.50.

For the contrarian investor it must also be encouraging to know that so many experts think the oil price can keep falling.

Goldman Sachs and Morgan Stanley are calling it to drop to $US20 a barrel, while Standard Chartered is talking $US10 a barrel.

In early 2008, when it was closer to $US120 a barrel, Goldman Sachs said it would hit $US200 and for a few months it did keep heading higher.

But by the end of that year the broker slashed its forecast for crude oil prices for 2009 to just $US45 a barrel.

To be fair, making it tough to forecast oil is the politics that sparks even more ­conspiracy stories than those found in all other financial market sectors.

On Tuesday night the oil price fell 3 per cent to $US30.44, while the talk on Twitter was if it kept falling at its current rate it would be free some time in February.

But not all analysts are that bearish. RBC Capital Markets has revised down its forecasts for oil in 2016 and 2017 but still thinks there will be a recovery to $US50 a barrel by the end of 2016.

It probably won’t happen until the second half of the year but the broker notes the size of the sell-off is reaching “historic proportions”.

The starting point for any sensible discussion about the 75 per cent collapse in the oil price over the past two years is to put it in the context of previous sell-offs.

In 2008 the oil price fell 53 per cent, in 2001 it fell 26 per cent, while in 1997 it fell 32 per cent and another 31 per cent in 1998.

It fell 31 per cent in 2015 and 46 per cent in 2014, Bloomberg says.

A long-term chart going back to 1983 also shows that the average price for oil since then has been about $US42 a barrel, with a high of $US145 in July 2008 and a low of $US10.42 a barrel in March 1986.

Over the past decade the average price has been closer to $US81 a barrel.

It’s also not unusual for the oil price to rebound the year after a big fall.

In 2009 it rose 78 per cent and in 1999, after two bad years, it increased 112 per cent.

What is unusual this time is the industry cartel, OPEC, has not responded with cuts in production, as it has done in previous years.

Instead, OPEC’s biggest producer, Saudi Arabia, refused to cut output at the cartel’s last meeting in December.

While they choose to flood the market with cheap crude and keep the pressure on shale oil drillers in the US and offshore operators in areas such as Britain’s North Sea, oversupply will remain and in this set-up it will be hard for the oil price to rise.

Traders will keep looking for statistics like the one that show inventories probably increased at a rate of 1.4 million barrels a day in 2015, when global demand for oil is generally accepted to be about 92 million barrels a day, as a sign that supply is still high.

The US Energy Information Administration also said on Tuesday that output from the United States would be 50 per cent higher than it was in 2010, thanks to the shale boom that boosted production by 1 million barrels a day from 2011 to 2015.

Until those production numbers turn down, or OPEC has a change of heart, oil prices will remain low.

But history shows it will turn and, for those investors brave enough, it might be time to take another look at the energy sector.

SLUGGISH GROWTH

One of the more genuine concerns investors have in 2016 is the lack of economic growth around the world seven years on from the worst of the global financial crisis.

It’s one reason China’s fourth-quarter gross domestic product, slated to be released next Tuesday, is so important.

It comes as the World Bank has already warned that global growth is tipped to recover at a slower pace than thought previously.

Growth around the world is forecast to reach 2.9 per cent in 2016, thanks to a small recovery in the US, but the bank makes it clear its forecasts are subject to substantial downside risks.

A further slowdown in the larger emerging markets like China could spill over to other developing economies and that would put the brakes on their already weak recovery.

For that reason, Wednesday’s trade data from China was well received when it showed the world’s second-largest economy finished 2015 with a far stronger than expected trade performance, implying that domestic demand remains resilient despite the recent turmoil on financial markets.

Exports for December rose 2.3 per cent from a year earlier, compared to expectations of an 8 per cent decline and well up from a 6.8 per cent drop in November.

One reason for the better than expected result was the record, in volume, of imports of iron ore from Australia, while demand for exports from Europe was also encouraging.

Similar to oil, the fall in the iron ore price is all about excess supply but the big difference is demand for iron ore is still strong.

Economists like TD Securities’ Annette Beacher think next week’s fourth-quarter GDP for China might surprise to the upside, but she is sticking with a forecast that will show the economy is still expanding at an annual rate of 6.9 per cent.

“Growth sceptics will of course attach downside, but they haven’t caught up with the ongoing rotation of growth away from heavy industry and towards the services sector,” she said.

A Reuters poll of 50 economists suggests growth has probably slowed to 6.8 per cent from the same period in the previous year. That would be the weakest pace of expansion since the first quarter of 2009, when growth fell to 6.2 per cent.

Source: AFR – When OPEC cuts output, oil prices will begin to climb

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