The violent speed at which oil prices have collapsed over the last seven months has taken global equity markets by complete surprise.
Back in June, Brent oil was trading at around US$115 a barrel while West Texas Intermediate (WTI) was around US$107 a barrel. The pair have since fallen to US$48.76 and US$45.15 respectively, reflecting a loss of roughly 58% each.
Indeed, there are mixed opinions regarding the direction of oil prices from this point on. While Iraq and South Africa have both expressed optimism – suggesting that oil prices won't fall much further from here – others are forecasting it to fall much lower. Iran, for instance, recently said it could bottom out at US$25 a barrel while Saudi Arabia said the days of US$100 per barrel would never be seen again.
Unfortunately, simple supply and demand economics suggest that the bears could be right this time around. The reality is that supply continues to heavily outweigh demand, and that seems unlikely to change anytime soon – even with the closure of various U.S. oil and gas rigs tipped over the course of the year.
As it stands, U.S. and Organisation of Petroleum Exporting Countries (OPEC) oil producers are engaged in a price war with neither wanting to back down from their production targets. Saudi Arabia, for instance, has made it clear that it is content with lower prices for as long as need be to ensure U.S. oil producers are priced out of the market (U.S. shale oil is more costly to produce than conventional oil). U.S. producers, on the other hand, will continue to improve their operating costs to ensure their operations remain economically viable.
While oil prices will eventually stabilise – whether it be via intervention from OPEC or the balancing out of market forces – the immediate outlook remains unclear for those companies operating in the energy sector. That could mean even more pain for companies such as Woodside Petroleum Limited (ASX: WPL), Santos Ltd (ASX: STO) and Senex Energy Ltd (ASX: SXY), which have already crumbled 20%, 48% and 60% over the last seven months. BHP Billiton Limited (ASX: BHP) and Oil Search Limited (ASX: OSH) could also see their shares drop even further.
Given the high level of volatility – and the likelihood of further losses – investors would be wise to steer clear of the sector altogether. While there will likely come a time for bargain-hunting, it certainly doesn't appear as though that time is now.