Oil at US$40, and below, gaining traction on Wall Street

[LONDON] Brace for US$40-a-barrel oil.

The US benchmark crude price, down more than US$60 since June to below US$45 on Tuesday, is on the way to this next threshold, said Societe Generale SA and Bank of America Corp. And Goldman Sachs Group Inc says that West Texas Intermediate needs to remain near US$40 during the first half to deter investment in new supplies that would add to the glut.

"The markets are continuing to price in huge oversupply in the first half of 2015," Mike Wittner, head of research at Societe Generale SA in New York, said by phone on Jan 12. "We're going to go below US$40."

Oil is seeking a "new equilibrium" as the Organization of Petroleum Exporting Countries abandons its role of keeping supply and demand aligned, according to Goldman. Prices are poised to drop further, testing the ability of US shale drillers to keep pumping.

WTI fell as low as US$44.20 a barrel on the New York Mercantile Exchange on Tuesday and traded at US$45.57 at 9:58am London time. The US benchmark has dropped 15 per cent this month, extending a 46 per cent plunge last year that was the worst since the 2008 financial crisis.

Opec Strategy Opec is trying to maintain its share of the global oil market against the rise of US output. United Arab Emirates Energy Minister Suhail Al Mazrouei reiterated yesterday that shale producers will capitulate before Opec to lower prices, the latest in more than a dozen comments from Gulf members aimed at hastening oil's slide and lowering non-Opec supply. The group upheld its target of 30 million barrels a day at a meeting in Vienna on Nov 27.

The rout may continue to US$35 a barrel in the "near term" because both oil supply and demand will have a delayed reaction to falling prices, Francisco Blanch, head of commodities research at Bank of America in New York, said in a report on Jan. 6.

The US is pumping oil at the fastest pace in more than three decades, helped by a drilling boom that's unlocked supplies from shale formations including the Eagle Ford in Texas and the Bakken in North Dakota. US output expanded to 9.14 million barrels a day in the week ended Dec. 12, the most since at least 1983, according to the US Energy Information Administration.

Reducing Investment With Saudi Arabia and other Opec nations no longer fine- tuning supply, reductions in investment in new production will be the instrument for removing excess output, Jeffrey Currie, head of commodities research in New York at Goldman said in a report on Jan. 11. This means the collapse will be deeper and the recovery slower than in previous slumps, he said.

Operating cash costs for many non-Opec projects are below US$40 a barrel and some producers will be able to keep going because they have locked in forward prices, or are supported by tax breaks or weaker domestic currencies, said Blanch, who on Nov 27 predicted that WTI, then above US$70 a barrel, could plunge to US$50. An increase in demand in response to lower prices will take about six months, he said.

"An impatient oil market, wanting to see production adjustments as soon as possible, could push WTI oil prices to US$40 a barrel," Giovanni Staunovo, an analyst at UBS AG in Zurich, said by e-mail on Tuesday. Investment "cutbacks and less drilling activity are required to see a stall in North American supply growth. This is unlikely to happen in a meaningful way before the second half," he said.

Cutting Supply While US drilling activity has slowed down in response to the price plunge, it will take months for that to translate into lower supplies, according to Societe Generale's Mr Wittner. Rigs seeking oil in the US decreased by 61 to 1,421, Baker Hughes Inc said Jan 9. That's the largest drop since February 1991.

"Rig counts are coming down, so it is happening the way it's supposed to happen," Mr Wittner said. "But it's going to take a while to see an impact on shale oil."

A seasonal lull in demand this quarter will add to the downward pressure from brimming inventories, pushing down prices as much as another US$10 a barrel, Amrita Sen, chief analyst at London-based consultant Energy Aspects Ltd. said in an interview on Bloomberg Radio's "Surveillance" on Jan 12.

"There is likely to be another leg lower for prices," said Mr Sen. "I wouldn't rule out a peek into the US$30s."

BLOOMBERG