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What goes down

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By Ed Crooks: January 29, 2016

The week has been a reminder that oil prices can go up as well as down. By Thursday night, Brent crude was 25 per cent higher than its low point eight days earlier. At a little under $34 per barrel, though, oil is still at a level that makes the great majority of US shale developments uneconomic. As I wrote in the FT on Saturday, it is pointing towards a radical shake-out in the shale industry.

Concerns about the huge financial strain that $30 crude imposes on oil producers and oilfield services companies has driven the value of junk-rated US energy debt down to its lowest level for more than two decades, at an average of just 56 cents on the dollar.  Markets have also become increasingly concerned about the domino effect from weak oil prices hitting other sectors, such as manufacturing. On balance, however, David Sheppard and Neil Hume argued in the FT, cheap oil is still better for the world economy than expensive oil.

The latest run-up in crude was in part driven by reports that Russia was ready to discuss an oil output cut with Opec. Javier Blas at Bloomberg suggested the talk was rooted more in hope than in expectation.

More realistically, the two blades of the scissors cutting away at low oil prices are both working. Some large US shale producers announced steep cuts in capital spending for 2016, after already reducing their investment sharply last year. A couple of them said that as a result their production would fall this year, helping to chip away at excess supply in the global oil market. Meanwhile, the foundations for stronger demand in the US are being laid by a boom in SUV sales, which rose 11 per cent last year and helped Ford achieve record earnings.

There was bad news for Opec, however, from Ed Morse of Citi, who argued the “new oil order” meant that if Russia and Saudi Arabia did agree to cut production, prices would rise to that a surge of new output from the US would rush in to fill the gap.

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