The Oil Market: McHugh’s Fearless Forecast For 2015 (Part 4)

Now that 2014 has closed, we want to present our view of where markets are headed in 2015 in a series of articles. The year 2015 will be historic, with unusual events and high market volatility. This weekend, Part 4, covers Oil.

The Oil Market

The cost of producing a barrel of oil, extracting it from shale, can be as much as $95 per barrel. Extracting oil from the ground reservoir is less expensive, and can range from $25 to around $35 per barrel. Cheaper for existing rigs. Given costs and required rates of return for the risk of drilling oil, the current price of oil, around $45 a barrel, may be too low to provide an incentive to produce. It means that recent gains in production from fracking, shale extraction, offshore and new well drilling overseas and in the U.S. will likely be lost, as Oil companies close down production operations. In a recent Wall Street Journal article, an analyst at Credit Suisse said, “We expect the market to lose at least 200 vertical and 200 horizontal rigs and it could easily be more than that.” Other experts are predicting more closings. Vertical rigs access deep underground Oil reserves while horizontal drilling is used in shale extraction. There is an increasing risk that small U.S. Oil companies will have to close their Oil wells and could go out of business. New Oil exploration could be stymied. This means there is a coming shortage of Oil. Supply will not meet demand, and that means prices will head higher.

The chart below shows that WTIC is likely to rise toward $200 a barrel over the next several years.

But there is more fallout coming. Russia’s economy depends upon Oil revenues. Its actions attempting to annex the Ukraine drew sanctions from the Western powers. Russia is intent upon revitalizing its military and world power. The decline in the price of Oil the second half of 2014 is a major deterrent to economic prosperity in Russia, further it is destroying the Russian economy. The Russian currency, the Ruble, is under enormous pressure, is collapsing. Russia just raised interest rates to 17 percent from 10.5 percent to defend its collapsing currency. In the beginning of 2014, the exchange rate between the U.S. Dollar and Russian Ruble was one Dollar bought 35 Rubles. At the end of 2014, one Dollar bought 64 Rubles.

Russia is collapsing into economic recession, and is at great risk of economic depression. The destabilization of the Russian economy increases the incentive for Russia to engage in warfare, even military warfare to acquire resources, punish adversaries, and acquire greater influence over world markets. Lower Oil prices gives Russia an economic incentive to take over Oil producing nations to better control Oil supplies, prices, Oil revenues and its own economy. The low price of Oil is an economic incentive for Russia to invade the Middle East. It also gives Russia an economic incentive to purchase more Gold, and boost the value of its currency by backing it with Gold. The recent plunge in Oil prices may be backing the Bear into a corner.

The low price of Oil is also a disincentive for major corporations to develop alternative sources of energy. Progress made in this arena could be retarded, or in some technologies halted.

A 55 percent collapse in Oil the past six months is not passing the smell test. This is more than a declining demand issue, or a rising supply issue. In my opinion, it smells like price manipulation is occurring for some political or economic agenda by powerful forces with the capability of accomplishing this. Clearly the majors will survive but the smaller oil companies are at great risk of being driven out of business. That spells higher prices and greater profits for the majors in the future.

Charts are telling us the recent decline in Oil prices will in effect cause a massive rise in Oil prices far above where they were before this price collapse. War could be a catalyst for rising Oil prices, as it would interrupt supply and increase demand dramatically.

From a technical analysis perspective, the big picture chart we show for Oil considers that Oil is inside a developing wave 4 down move of an eventual five wave rally leg. This five wave rally leg is a Rising Bearish Wedge.  If we draw trend lines connecting the recent lows and the recent highs, what we get is a developing sideways triangle, a huge triangle. The recent decline the past six months was wave c-down of this five wave triangle. Oil should be bottoming now. Next, in 2015, would be wave d-up which should take Oil back as high as $95 a barrel by late 2015, projecting a price path to where the top of the declining upper boundary of this sideways triangle sits. Then Oil should decline into wave e-down, to a low of around $70, the rising bottom boundary of the triangle. Once this triangle is finished, Oil should spike toward $200 a barrel in wave 5-up a few years from now.

Oil is working through a five wave mega-rally that started in 1986. It is currently inside a developing five-subwave sideways triangle for wave 4-down. The middle wave of this triangle, wave c-down, is completing now, and has been the crash in oil prices the past six months. Once this decline is complete, Oil should rise toward $95 a barrel, wave d-up (stopping at the upper boundary of the triangle. Then wave e-down will take oil back down toward $70 a barrel. Once wave 4-down is complete, oil will catapult toward $200 a barrel, or higher in wave 5-up.

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Robert McHugh Ph.D. is President and CEO of Main Line Investors, Inc., a registered investment advisor in the Commonwealth of Pennsylvania, and can be reached at www.technicalindicatorindex.com.  The statements, opinions, buy and sell signals, and analyses presented in this newsletter are provided as a general information and education service only.  Opinions, estimates, buy and sell signals, and probabilities expressed herein constitute the judgment of the author as of the date indicated and are subject to change without notice.  Nothing contained in this newsletter is intended to be, nor shall it be construed as, investment advice, nor is it to be relied upon in making any investment or other decision.  Prior to making any investment decision, you are advised to consult with your broker, investment advisor or other appropriate tax or financial professional to determine the suitability of any investment.  Neither Main Line Investors, Inc. nor Robert D. McHugh, Jr., Ph.D. Editor shall be responsible or have any liability for investment decisions based upon, or the results obtained from, the information provided. Copyright 2015, Main Line Investors, Inc. All Rights Reserved.