Beware: The End of OPEC Could Mean a Plunge to $20 Oil

By Markets Fool.com

Just when investors thought the oil rout was over, an analyst at Citi warned that the recent 20% rally in the price of oil is just a "head fake." Worse yet, Citi sees the price of oil resuming its plunge and going all the way down to $20 per barrel. That's quite the opposite view of many others as OPEC said it thinks that oil has already bottomed and could zoom higher while the International Energy Agency, or IEA, sees $55 oil being here to stay this year. However, as we've seen in this market, anything is possible once OPEC steps aside.

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Ruining the rally
A big drop in the U.S. rig count over the past few weeks should lead to a slowdown in U.S. oil production growth, which has largely fueled the rally off the bottom in recent weeks. However, Citi doesn't see that slowdown being enough to maintain the rally in the price of oil. Instead, it sees the glut getting far worse, which is why it's predicting a new plunge in oil prices that could take crude all the way down to $20 a barrel for a while. This is because it doesn't see OPEC stepping in to cut production in order to manipulate prices. Basically, it believes OPEC's days of ruling the oil market are over as U.S. shale has broken its ability to control the oil market with supplies alone.

Photo credit: Flickr user Anders Sandberg.

OPEC clearly has changed tactics as it has gone from protecting the price of oil to protecting its share of the oil market. This is clear from its recent statements that it is not going to cut production no matter how oversupplied the market gets. We saw this just the other day after OPEC revised its supply growth projection from non-OPEC nations. In that revision OPEC shaved 420,000 barrels off of the supply of its rivals and allocated 400,000 of those barrels to its output. However, the oil cartel noted that even with that cut it still had 1 million barrels of oil per day that didn't have a home, but it was going to keep pumping that oil until it has pushed out other rivals.

Until those rivals begin to reduce their output, or demand for oil improves, all that extra oil is heading into storage. The problem with that is that storage is quickly filling up. In fact, some oil traders are leasing oil tankers to store oil at sea in hopes of selling it at a profit if oil prices rebound later this year. This glut of oil in storage is why Citi sees a new plunge in the price of oil. The market is pumping out so much oil with no place to go at the moment.

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Not everyone agrees
That said, others aren't quite as bearish on oil prices. While not overall bullish, the IEA recently put out its "Medium-Term Oil Market Report" in which it sees the price of oil averaging around $55 per barrel this year. That's well below last year's report where it saw $100 oil in 2015 and 2016, which just goes to show that no one really has a clue what the price of oil will do in the future. That being said, the IEA doesn't see a renewed plunge in the price of oil, nor does it see any reason for its recent rally to continue. In fact, it sees oil climbing to just $60 a barrel in 2016 and heading to just $73 a barrel by the end of the decade. That's clearly not the news that oil companies want to hear as many are hoping for a return to much more lucrative oil prices.

One of the reasons for this less bullish forecast is because the IEA also sees OPEC no longer stepping in to provide stability to the oil market. It noted that, "the rules of the market have changed" and that the industry can't, "count on OPEC to act as a swing producer and cut output in the event of a price drop." However, that doesn't necessarily mean OPEC won't cut at some point. It has made it clear that it won't take the brunt of the cut as it only produces a third of the world's oil, but it might meet its non-OPEC rivals a third of the way at some point as long as it sees their output dropping the rest of the way.

Investor takeaway
That shift in policy caught everyone off guard as OPEC traditionally stepped in and adjusted its output whenever the oil market went off track. With it clearly out of the picture, at least for now, the industry needs to fix its supply issues on its own and that will take time as oil companies don't want to shut down producing wells. That said, this doesn't necessarily mean oil is going to plunge again as the problems are slowly being worked off. Production growth is slowing while demand for oil is starting to pick up a little bit as American drivers are reinvesting their savings at the pump by driving more. So, while visibility on the road ahead is still cloudy, it is at least clearing up a bit.

The article Beware: The End of OPEC Could Mean a Plunge to $20 Oil originally appeared on Fool.com.

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