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Why the oil price could plunge further

Credit: rabiem22

As you will know if you own oil shares and checked your portfolio yesterday –  the value of Brent Crude oil slipped under US$29 a barrel earlier this week.

This is the lowest that prices have been since 2003, and the latest falls come on the back of the removal of sanctions against Iran, which could reportedly add up to 500,000 barrels a day to global oil supply.

Australian oil shares were understandably smashed as a result, with Santos Ltd (ASX: STO), Woodside Petroleum Limited (ASX: WPL), and Origin Energy Ltd (ASX: ORG) losing 9%, 2.5%, and 5% since the close of trade on Friday.

According to the International Energy Agency, total global oil supply was around 97 million barrels a day as of 11 December 2015. The increased output from Iran therefore equates to about a 0.5% increase in total supply – not particularly significant, except in an already oversupplied market.

Shareholders in smaller producers like Beach Energy Ltd (ASX: BPT), Senex Energy Ltd (ASX: SXY), and Drillsearch Energy Limited (ASX: DLS) are likely wondering where the rot will stop, given that low prices are placing significant pressure on their businesses.

From what I’ve seen in the market, it looks as though it’s a reality for investors that low oil prices are here to stay for the foreseeable future. Speculating on oil looks quite appealing if you expect prices will bounce back to US$100/barrel, although as I wrote in this article a month ago, investors must be sure to contrast the size of the profits they could make with the likelihood of actually making a profit.

Indeed, prices could potentially fall further as the new supply enters the market and if economic conditions in places like China deteriorate. Oil/gas producers in more precarious financial positions like Santos, or the smaller producers should be considered highly risky.

Over the longer term (3-5 years or so), there is significant potential for a subsequent rebound in oil and gas prices as a result of falling supply due to bankruptcies and current cuts to capital expenditure budgets (which will reduce the amount of future supply coming on-line).

However, there is also significant potential for cleaner technologies such as solar energy and electric cars to become more widely used in this time, possibly impacting demand for oil and gas. This is in addition to the risks to your wealth that come from holding unprofitable or marginally profitable companies for several years.

Investors should be sure to do their research before investing in the oil sector right now.

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Motley Fool contributor Sean O'Neill owns shares of Senex Energy Limited. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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