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Oil prices will get worse before they get better: Analysts

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By Tom DiChristopher: 13 Jan 2016

After U.S. crude prices broke below $30 per barrel for the first time in 15 years, the market is asking how low oil futures can go? Most analyses see it rebounding in the back half of 2016, but crude faces significant headwinds in the coming months, experts told CNBC.

On Monday, Morgan Stanley joined Goldman Sachs in saying oil prices could dip to $20, and a number of major banks cut their crude cost outlook this week. Standard Chartered even raised the specter of $10 oil.

Oil as low as $20 — and perhaps even lower — is indeed possible, said Matt Smith, ClipperData’s director of commodity research.

“It seemed outlandish that we would get down to this level, but by all means, we could drop another $5-10 here,” he told CNBC’s “Squawk Box” on Wednesday. “Now we’ve tested the two-handle here and the weakness is really going to come over the next sort of three, six months as the market looks to rebalance.”

Global oil production has so far remained stubbornly high despite a roughly 70 percent collapse in crude prices since mid-2014.

U.S. output in particular has weathered an OPEC policy engineered by Saudi Arabia to preserve market share and pressure higher-cost production. American drillers maintained output above 9 million barrels per day throughout 2015, according to the latest available figures from the U.S. Energy Information Administration.

But current prices are squeezing U.S. shale oil producers and other drillers around the world, said Smith. He noted that the EIA on Tuesday forecast American output would average 8.7 million barrels per day this year, slightly lower than an earlier estimate.

“When you’re getting down to sort of below $30, that’s the lowest cost production across a lot of the world, so really at some point there is going to be some rebalancing,” he said.

Raymond James analyst Darren Horowitz also said the situation would get worse before it gets better.

“Everybody … seems to be — I think from a consensus perspective — bullish on a recovery in the back half of this year, and there are still some structural issues that need to get cleared up before crude oil prices can have a meaningful tailwind,” he said.

The oil market is entering a period of significant refinery maintenance at home and abroad, he told CNBC’s “Squawk on the Street” on Tuesday. U.S. refinery maintenance alone could take 1 million to 1.5 million barrels of capacity per day offline, he said.

China’s series of yuan devaluations also raises concerns about the cost of crude, which is priced in U.S. dollars.

“If we see further, on a global basis, currency devaluation that causes a spike in the dollar, that will send crude oil prices lower in the short term,” he said.

In the very near term, there are thousands of options to sell oil futures that need to be cleared up this week, he noted.

Doug Terreson, a top-rated energy analyst at Evercore ISI, said Tuesday market watchers should be “pretty worried” about the sustainability of some oil producers at current commodity price levels. He told CNBC’s “Fast Money: Halftime Report” almost every recent fundamental and strategic indicator has raised red flags.

On the demand side, the International Monetary Fund and World Bank have lowered projections for global economic growth, he said. On the supply side, OPEC members, particularly Saudi Arabia, have indicated they would increase production should demand rise, he added.

Terreson said he is concerned that the decades-old compact between the United States and Saudi Arabia to exchange U.S. security and support for oil market stability has been severed. Elevated strife between the Saudis and Iran also reduces the likelihood of cooperation in OPEC in 2016, he said.

Saudi Arabia and several of its Gulf and African allies severed or reduced diplomatic ties with Iran after protesters stormed and set fire to the Saudi embassy in Tehran following the Saudi execution of a Shiite cleric. Iran is a majority Shiite nation, while Saudi Arabia’s ruling monarchy adhere to the Sunni branch of Islam.

Ultimately, geopolitical tension could support prices, ClipperData’s Smith said, noting Iran and Saudi Arabia are fighting proxy wars in Syria and Yemen and terrorists from so-called Islamic State have targeted Libya’s oil infrastructure.

“The market — because oversupply is there, because inventories are strong — it isn’t really particularly concerned about that, and that really could be the black swan to push prices higher from here,” he said.

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