Crude Oil Forecast: 17% drop in 2 weeks

Crude Oil Forecast: Crude Oil Falls Close To $60 Per Barrel

Brent and West Texas Intermediate, crude oil futures, traded near their lowest prices since July 2009. Simple economics in the shape of supply and demand have played a large part in this fall. Persistently high oil prices over the last few years prompted a fracking revolution in the U.S. The oil boom has been driven by a combination of horizontal drilling and hydraulic fracturing, which has unlocked supplies from shale formations including the Eagle Ford in Texas and the Bakken in North Dakota. Production in the U.S. expanded to 9.12 million barrels a day through December 5th, the fastest rate in weekly records that started in 1983 according to the Energy Information Administration. The increased supply of oil has led to a supply glut worldwide.

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Meanwhile, demand has also decreased. China had driven demand growth in oil for years, but they are starting to reach capacity constraints. The Chinese economy has seen slowing growth as a whole, and the struggling European economy have helped to keep demand growth under wraps. The International Energy Agency estimates a 2014 oil demand of 92.4 million barrels a day, reflecting annual growth of just 680,000 barrels. This is the weakest growth rate in five years. Economist Andy Xie, who predicted the oil price plunge in September as China’s energy demand tapered off, believes oil prices will stay around $60 a barrel for the next five years.

The supply and demand factors have not been helped by the OPEC’s decision last month not to curb supply as prices dropped. Saudi Arabian Oil Minister Ali Al-Naimi believes that the market will correct itself. While oversupply put the commodity price under pressure, the lack of a response from OPEC, and Saudi Arabia in particular, exacerbated the issue according to Eugen Weinberg, head of commodities research at Commerzbank AG in Frankfurt. Recent remarks from Al-Naimi make it clear that Saudi Arabia does not plan to limit supply anytime soon, as they seem intent on protecting their market share and squeezing out fringe suppliers. OPEC’s three largest members offered the deepest discounts on exports to Asia in at least six years, worsening the situation.

OPEC’s decision to maintain output at current levels amid falling prices has led to speculation that the 12-member group has become ineffective. Many analysts believe that the group has given up on its traditional role of keeping supply and demand in check. Saudi Arabia, one of the leaders of OPEC’s decision making processes, is unlikely to agree to limit their supply as they would lose market share to Iran, with whom theyengage in proxy wars for regional dominance. However, the group has overcome worse, including bloody wars between member countries, such as between Iran and Iraq and between Iraq and Kuwait. OPEC producers will experience discomfort if prices remain at their current lever, but other producers would struggle even more. Lower prices would squeeze U.S. capital spending hard given how much debt there is in that sector.

Simple supply and demand and geopolitical forces are not the only things to have impacted oil’s falling price.Federal Reserve policy and the U.S. dollar exchange rate have also played a role. Oil is priced in U.S. dollars. This linkage means that the price of oil goes down when the U.S. dollar goes up against foreign currencies, such as the euro or the yen. It is now clear that Asian and European economies are slowing down while the U.S. economy is growing. Investors have been buying dollars to invest in the U.S. economy, and the U.S. dollar index, which measures the dollar against a basket of foreign currencies, has been performing at its best level in years. At the same time, the Federal Reserve is tightening the money supply by no longer buying bonds and is expected to raise interest rates soon while central banks in Europe and Asia are trying to kick-start those economies, only causing investors to keep buying dollars keeping oil prices low.

Algorithmic Analysis

I Know First is a financial services firm that utilizes an advanced self-learning algorithm to analyze, model and predict the stock market. The algorithm produces a forecast with a signal and a predictability indicator.  The signal is the number in the middle of the box. The predictability is the number at the bottom of the box.  At the top, a specific asset is identified. This format is consistent across all predictions.

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The signal represents the predicted movement direction or trend, and is not a percentage or specific target price. The signal strength indicates how much the current price deviates from what the system considers an equilibrium or “fair” price. The signal can have a positive (predicted increase) or negative (predicted decline) sign. The heat map is arranged according to the signal strength with strongest up signals at the top, while down signals are at the bottom. The table colors are indicative of the signal. Green corresponds to the positive signal and red indicates a negative signal. A deeper color means a stronger signal and a lighter color equals a weaker signal.

The predictability indicator measures the importance of the signal. The predictability is the historical correlation between the prediction and the actual market movement for that particular asset, which is recalculated daily. Theoretically the predictability ranges from minus one to plus one. The higher this number is the more predictable the particular asset is. If you compare predictability for different time ranges, you’ll find that the longer time ranges have higher predictability. This means that longer-range signals are more important and tend to be more accurate.

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The figure above is an algorithmic forecast for oil from November 26th, 2014, for the 14 day time horizon. The algorithm was bearish for oil, as two different oil indexes had negative signal strengths. The algorithm proved to be correct, as oil prices dropped over 17% over the next two weeks.