Oil crash could be ‘far worse than 1986’, says Morgan Stanley
Brisbane Times, 24 July 2015
Morgan Stanley has been pretty pessimistic about oil prices in 2015, drawing comparisons to the some of the worst oil slumps of the past three decades. The current downturn could even rival the iconic price crash of 1986, analysts had warned – but definitely no worse.
While for now, it is sticking with its original thesis that prices will improve, Morgan Stanley has revised its worst-case scenario, saying the crash has the potential to be 'far worse than 1986'.
Until recently, confidence in a strong recovery for oil prices – and oil companies – had been pretty high, wrote analysts including Martijn Rats and Haythem Rashed, in a report to investors. That confidence was based on four premises, they said, and only three have proven true.
OPEC production surges in 2015. Photo: Source: Morgan Stanley Research, Bloomberg
1. Demand will rise: Check
In theory: The crash in prices that started a year ago should stimulate demand. Cheap oil means cheaper manufacturing, cheaper shipping, more summer road trips.
In practice: Despite a softening Chinese economy, global demand has indeed surged by about 1.6 million barrels a day over last year's average, according to the report.
2. Spending on new oil will fall: Check
In theory: Lower oil prices should force energy companies to cut spending on new oil supplies, and the cost of drilling and pumping should decline.
In practice: Sure enough, since October the number of rigs actively drilling for new oil around the world has declined by about 42 per cent. More than 70,000 oil workers have lost their jobs globally, and in 2015 alone listed oil companies have cut about $US129 billion in capital expenditures.
3. Stock prices remain low: Check
In theory: While oil markets rebalance themselves, stock prices of oil companies should remain cheap, setting the stage for a strong rebound.
In practice: Yep. The oil majors are trading near 35-year lows, using two different methods of valuation.
4. Oil supply will Drop: Uh-oh
In theory: With strong demand for oil and less money for drilling and exploration, the global oil glut should diminish. Let the recovery commence.
In practice: The opposite has happened. While US production has levelled off since June, OPEC has taken up the role of market spoiler.
For now, Morgan Stanley still believes prices will improve, largely because OPEC doesn't have much more spare capacity to fill and because oil stocks have already been hammered.
But another possibility is that the supply of new oil coming from outside the US might continue to increase as sanctions against Iran dissolve and if the situation in Libya improves, the Morgan Stanley analysts said.
US production could also rise again.
A recovery is less certain than it once was, and the slump could last for three years or more – "far worse than in 1986."
"In that case," they wrote, "there would be little in analysable history that could be a guide" for what's to come.