During a market turmoil, any asset can drop severely and investors who are trying to catch the bottom of this free fall end up losing their money and sometimes their fortunes in the process. During such an environment, it is rather difficult to tell whether the drop in the price is heading for a crash or is only a correction, often a short-term one.
The recent drop in the oil prices reminds us about the dilemma faced by every investor or trader: is it a crash or a short-term correction? Oil prices dropped by more than 35% since early summer and more than 50% from its top of 147 USD a barrel which was reached in 2008. When you have such a severe drop, you start to ask to yourself whether it is time to buy it? A correction of 50% is enough for many investors and traders to start buying but what if it were to drop further to 60 USD a barrel? One should look for the possible catalysts that would permit a comeback of the oil...
A low price in oil stimulates the demand in many related sectors but diminishes the exploration and development thus reducing the oil supply with time. At one point, the demand starts to push the price of oil until a point is reached where the imbalance between supply and demand reverses the process and we have a severe drop if not a crash in the price of oil.
Currently, many oil producers (many of them being high-cost producers) have a break even price in the range of 60-70 USD and if the prices were to continue to drop, they will get into trouble: their budgets for capital expenditure will record a loss and a drop in the supply will follow; currently, there are deferrals and delays and their cost structure don't make that profitable at 70 USD a barrel. And the long-term outlook for the industry is moderate; in fact, the price of the barrel may remain flat around 70 USD for some time to come.
But there is also the production level of the conventional oil approaching the peak level. Despite the development of the unconventional oil production (oil sands, U.S. oil shale, biofuels and natural gas liquids), the drop in the price of oil will hurt their production as they are costly. Their production determines the growth in the production of oil in general and they depend too much on higher price levels. Further, the current levels of the oil prices will hamper the development of electric and /or hybrid cars as their operating costs are higher.
The oil producing countries in the Middle-East and Africa, as well as Russia need prices that are higher than 70 USD a barrel in order the break-even with their budgets (Russia has a break-even level of 85 USD a barrel) . Saudi Arabia has a strong financial position which will permit her to withstand for long years of low prices (thus allowing her to drive out competitors such as U.S. oil shale producers) but the other oil producing states do not have that luxury; if the low prices persist for some time, they will reach a limit and production cut will follow thus driving up the price of oil.
The energy stocks got hurt from this process and we can find many beaten stocks in the industry. This also leads us to believe that one should feel bullish as far as the pessimism is concerned. The depressed energy sector forces us to think that there are some value stocks present there but currently the investors look to the short-term. With no replacement of the fossil fuel in the near future, the long term outlook of the sector is still bright. The most important factor which affects the oil price is the growth in the world's economy and the current slow growth is affecting adversely the price of the oil. But a surge in the demand for oil from countries such as China and India will create a shortage in the supply of oil and the price will go up. And the current selloff witnessed in the energy sector is currently telling us that the worst being left behind; soon, a rebound will start but it will be a slow one. Nevertheless, the price of oil should fluctuate in an upward trend, reaching the target price of 180 USD a barrel in the long run.
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