Do Oil Prices Have Room To Fall Further?

Folks hitting the road for July 4th this year won’t have much to complain about at the gas pump.  The day before the holiday, AAA reports that regular unleaded averages a mere $2.23 per gallon nationwide: The lowest price for early July since 2005. (Of course, that nationwide average includes some sharp regional variations. Californians are paying roughly $2.94 per gallon of regular. In South Carolina, the statewide norm is $1.90.) It’s hard to believe that just three years ago, the nationwide average price was $3.68 per gallon.

Of course, drivers can thank the oil market for those savings. The world has been awash in excess crude for more than two years now, and oil prices have plunged during that time. Even with OPEC limiting its oil exports to shrink the supply glut, prices have remained stubbornly low. Benchmark West Texas Intermediate showed some signs of rallying this spring, but topped out at about $53 per barrel in April before retreating below $50 again. In fact, WTI technically entered a bear market when it closed at $42.53 on June 21, marking a 20% decline from its April peak. (A small rebound has taken crude back to about $46.50.)

Now, investors are starting to worry that oil’s slide could cause serious financial pain, both for the energy industry and for the broader stock market. The oil industry is a major employer as well as a huge customer for manufactured goods. Swooning crude prices could jeopardize the surge in drilling activity, weighing on sales of everything from steel pipe to pump jacks.

So, just where are oil prices going?

A few weeks ago, when WTI was sliding, I checked in with Stephen Schork, editor of energy investing newsletter The Schork Report, to ask that very question. WTI was hovering around $45 per barrel, and he warned that oil bulls faced a “do or die” moment. If prices didn’t soon stabilize, WTI could fall below $40: A damaging decline for an industry already battered by low prices. His reasoning: Oil demand is bound to slip when summer turns to fall and Americans wrap up their summer road trips. So, the market will be vulnerable to a sharp downturn if prices are already weakening at the start of summer, when demand is robust.

Crude prices did slip further after our conversation, but only briefly before rebounding to the mid-$40s. And there are some signs that the worst could be over. U.S. gasoline demand is looking especially strong so far. In fact, the final week of May saw an all-time high for gas consumption of slightly more than 9.8 million barrels per day.

Meanwhile, energy firms might finally be slowing down their frantic pace of drilling new wells. Oilfield services company Baker Hughes’ closely watched “Rig Count” showed two fewer oil rigs operating last week than the week before: A rare decline after a steady string of increases going back to last year. Odds are that U.S. oil production will keep rising because so many new wells have recently been drilled, and because producers are coaxing more crude from each new well. But the flood of new oil coming from Texas, Oklahoma and other states might slow to more of a trickle if drilling activity moderates.

OPEC remains a wildcard for oil markets. So far, the cartel has been remarkably disciplined in sticking to its production quota. But that hasn’t reduced global oil supplies enough to raise prices yet, in large part because OPEC members Libya and Nigeria are exempt from the agreement. Both have managed to ramp up exports recently. In fact, the International Energy Agency reports that OPEC’s collective production hit a monthly high in May because of rising output in those two countries. Cutbacks by Saudi Arabia and other members don’t do much to rein in excess supply if their cuts are offset elsewhere.

My best guess is that oil prices are unlikely to rally much, but aren’t yet in danger of falling off a cliff, either. The global supply glut won’t disappear quickly. But there are reasons to believe it won’t worsen. And demand is chugging along at a healthy clip. Given all of that, I look for WTI to trade somewhere in the low- to mid-$40s per barrel in September, fairly close to today. Of course, there will be some short-term spikes and dips between now and then as market volatility remains elevated.

Oil producers won’t have much to celebrate if I’m correct in my price outlook. But most won’t be going belly-up, either. And drivers will continue to enjoy fill-ups that are relatively pain-free.