Oil Is Going to US$85 by Christmas – Here Are the Cold, Hard Facts

I recently gave my view on where I thought oil prices were likely to go in 2016 back in January. While I felt (and explained why) they were definitely headed higher in the second half, I didn’t put a number on how much higher.

One of the better fundamental oil market analysts around agrees with many of the points I made back in January and is willing to offer a specific price target. Brave soul…

His number is US$85 per barrel by Christmas! That certainly seems a bit optimistic, but if it happens, it would definitely put a few more presents under the Chudley Christmas tree this year.

Market set prices often change faster than you could ever have imagined

To get to that $85 per barrel oil price by Christmas, a very large increase in the price of oil is going to have to happen. Just by using my fingers and toes, even I can decipher that we are going to require the price of oil to double.

I’ve always found it very hard to believe that big price swings like this can happen over such a short period of time. Yet they regularly do, especially in extreme circumstances like we have in the oil market today.

I will never forget staring at my computer screen and watching shares of early Bakken mover Kodiak Oil & Gas hit 16 cents on 12 March, 2009. I remember looking at that share price and thinking that it was going to take 20 years for Kodiak shareholders to ever see the $4 level that shares had traded at only a few months earlier.

To get from 16 cents to $4.00, Kodiak shares needed to go up 25 times. That would take a fantastic increase over 20 years.

I was way off in my 20-year estimate. It didn’t take 20 years for Kodiak to get to $4.00 — it took 12 months.

My point is that the market works in mysterious ways. When an entire market that has been betting against a certain stock or commodity suddenly gets wind that they are wrong, the rush in the other direction can be amazingly swift and the market price move shockingly large.

Perhaps that is what we are set up for in oil in 2016. The move off the bottom is already nothing to sneeze at.

Counting barrels, not making guesses

I try to make sure I always pay attention to what Mike Rothman of Cornerstone Analytics is saying about where oil is headed. I like Rothman because his opinions are backed up by extensive hard data and not gut feel.

Rothman counts barrels. As in how many barrels of oil are sitting in inventory around the world.

By watching how much inventory levels are changing, he can determine how far out of whack daily oil supply and demand is.

If inventory levels go up by 30 million barrels in a month, Rothman concludes that the market is oversupplied by one million barrels a day. It is simple, but it also makes sense. The inventory data are the best that we have on the oil market.

Rothman’s method is far superior to what the EIA, IEA and OPEC reporting bodies do. These bodies make estimates of supply and demand and then have a ‘plug’ in their numbers to explain why inventory levels aren’t moving as they would have expected.

I wrote about the IEA’s massive ‘plug’ last year in more detail and explained how every year without fail they have to revise their numbers to correct the same mistake they keep making.

Rothman completely takes estimation, guessing and imprecision out of the mix. He counts barrels, and that is it. His opinions are drawn from 100% objective data.

Rothman has been far more bullish than the IEA, EIA and others. He believes that the other agencies have vastly underestimated global oil demand figures.

That shouldn’t come as much of a shock.

The IEA has been repeatedly underestimating global oil demand. I’m not talking about the last couple of quarters. The IEA has been underestimating demand for years.

It works like this: the IEA makes an initial demand estimate at the time its highly covered report is released. That is the report that the market follows and trades on. Then later on, as better quality data come in, the IEA has to revise those initial estimates upward to the actual figure.

According to Raymond James, the IEA has had to revise its initial demand estimates upward in 14 of the last 15 years. The average adjustment to demand has been an incredible 700,000 barrels per day.

For 15 years, they have been making the same mistake repeatedly without doing something to fix it.

Of course, nobody notices those after-the-fact revisions, because they receive zero coverage in the media. And the IEA certainly doesn’t make an effort to draw attention to the revisions. Why would they? It has to be embarrassing after 15 years.

This isn’t a theory of mine. This is a fact: the same mistake over and over again.

How Rothman thinks we get to $85 oil by Christmas

The IEA has been wrong about demand all along, yet the market has still kept oil prices incredibly low.

What is going to change to get the market moving hard enough in the other direction that we could somehow get to $85 per barrel by year-end?

According to Rothman, it will be a fall in global oil inventories that is going to happen in dramatic fashion.

The chart below provides his view of the next nine months:

Global Oil Inventories
Source: The Daily Reckoning US
Click to enlarge

Rothman sees more than 500 million barrels being sucked out of global storage by the end of 2016. If that actually comes to pass, I don’t think his $85 price target by year end is the least bit unrealistic.

Rothman’s year end oil inventory target would have us down to inventory levels not seen since 2013, when oil was $100 per barrel at times.

Rothman and his team at Cornerstone believe that OECD inventory levels drew unexpectedly in March 2016 following a similar unexpected draw in February 2016 and a much-smaller-than-expected gain in January 2016.

March OECD Stock Change
Source: The Daily Reckoning US
Click to enlarge

The strength in oil prices in recent weeks could quite likely be more and more market participants starting to see what Rothman has picked up on.

If he is right, the party is truly just getting started.

Keep looking through the windshield.


Jody Chudley,
For Money Morning

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