Alahdal is a petroleum industry professional and a committee member at the Society of Petroleum Engineers. He is an oil and gas industry analyst at Offshore Post

Alahdal A. Hussein

Morgan Stanley’s Oil Prices Forecast is Wrong; Oil is Heading to $50

Published at 08:48AM - 11/05/16

The Wall Street Journal has conducted a survey in April 2016 to get an overview of the oil prices direction in the next few quarters as seen by 13 investment banks.

And despite the current rally in oil prices, the survey shows that analysts are doubting the rally and apparently many of them are still in the pessimism state.

According to the survey, investment banks’ forecasts for oil prices have not changed much from a similar survey conducted by The Wall Street Journal in March 2016.

The survey shows that the banks see Brent crude and West Texas Intermediate averaging $41 and $39 a barrel this year respectively. That represents a change of only $1 up from March’s survey for Brent crude and no-change from March’s survey for West Texas Intermediate.

Crude Oil Price Forecast
Source: Wall Street Journal

While few investment banks’ forecasts fall in a range close to the current direction of the oil prices, a notable forecast that points to a different direction is coming Morgan Stanley.

The reputable investment bank along with other investment banks such as ING and BNP see oil prices falling in the third quarter of 2016. Although the analysts at Morgan Stanley have predicted the fall of oil prices to $20s earlier this year, they are now wrong in their forecast and here is why.

1- Morgan Stanley’s forecast ignores the change in fundamentals

Some analysts including those at Morgan Stanley believe that the current rally in oil prices could mimic last year’s when Brent crude increased about $20 a barrel between January and May before falling later in the year. They are also worried about the current U.S. stockpiles and the potential for increased oil output from Iran. Although these threats are real, the analysts seems to be ignoring the fact that circumstances have changed.

Last year when oil prices jumped about $20 a barrel between January and May, the oil market downturn was just at its beginning.

According to the EIA, the global oil over-supply ( supply minus demand ) was growing at that time where it increased from about 2 million barrel per day in January 2015 to about 2.3 million barrel per day in May 2015 before reaching its highest level at 2.51 million barrel in August 2015. Crude oil supply was increasing dramatically while demand was lagging.

U.S. crude oil production was also growing during that time where it increased from about 9.15 million barrel a day in January to about 9.4 million barrel a day in May before hitting its highest level at 9.6 million barrel a day in July 2015.

It is obvious that during the January-to-May 2015 rally, all sentiments were pointing toward a further fall in oil prices and that is exactly what happened from May 2015 onward.

But this year, things are totally different than they were in 2015, from fundamentals to oil market cycle emotions. First of all, unlike the January-to-May 2015 rally, U.S. crude oil output is dwindling at an accelerating decline rate. The U.S. crude oil production has fallen from 9.2 million barrel a day in January 2016 to 8.9 million barrel a day in April 2016. U.S. rig count is also experiencing a sharp and continuous decline since the beginning of 2016. According to Baker Hughes, U.S. Rig Count is down 485 rigs from last year at 905, and the decline in rig count is still intensifying.

In addition to that, the global over-supply is easing with supply decreasing and demand increasing. According to IEA’s Oil Market Report, global oil supplies fell from about 97.2 million barrel a day in the 4th quarter of 2015 to about 96.2 million barrel per day in the 1st quarter of 2016.

Demand has also improved since last year where the global demand increased from 93.6 million barrel a day in the 1st quarter of 2015 to about 94.8 million barrel a day in the 1st quarter of 2016. Currently, the oil market fundamentals are totally different from those during the January-to-May 2015 rally, yet analysts chose to ignore these changes and focus on events such as the increase of Iran’s oil output which time has proven it has little to no effect on the oil market.

2- Morgan Stanley’s forecast is not consistent with the market cycle emotions

Back in January 2016, when analysts at Morgan Stanley and other investment banks predicted oil prices to fall to $20 a barrel, they did it at the right time. Eventhough oil prices didn’t fall to the level they have predicted, it fell below $30 a barrel.

At that time, the oil market was at its worst state, pessimism was ruling everything. And when the analysts predicted prices to fall to $20 a barrel and below, what they did was fueling the pessimism and pressuring oil prices to fall. Unfortunately, they succeeded in dragging oil prices down only because they played with the right emotion in the right direction at the right time.

But that is not the case now with their current pessimistic forecast. They are playing with the wrong emotion in the wrong direction at the wrong time. Right now, the oil market cycle emotion is optimism and events that have taken place in the oil market during the last few weeks support this fact.

For instance, despite the failure of Doha’s meeting, and the fact that Iran is ramping up its oil output, oil prices were able to sustain their gains and continued increasing. In fact, just a few days after the failure of Doha’s meeting, oil prices continued their gains, breaking out of a trading band. This shows the high level of optimism the oil market is in right now which some analysts underestimate its ability to drive prices up.

It should be clear by now that the direction of the oil market at this moment is different from that predicted by Morgan Stanley’s analysts and other investment banks which suggest that oil prices would fall again in the coming months. Judging by the improvement in oil market fundamentals and the current high level of optimism in the market, oil prices will continue its rally and it could reach to $50 a barrel in the coming weeks.

It is expected that oil prices will remain in a range between $40 to $60 per barrel till the end of 2016. Oil traders at this moment are very optimistic and they are looking for a hope in anything whether it is the weakening U.S. dollar or the declining U.S. crude oil output and rig count.

Hope and optimism is required to get the market out of this period and sustain oil prices at the current level or a little bit higher till market fundamentals improvement intensifies. Once the oil market fundamentals play its role completely, it will take charge of balancing the market and driving oil prices.

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