Oil price ‘could sink to $40 a barrel’

A glut of supply has been blamed for the price of oil dipping below $50 per barrel last week, as measured by the internationally recognised Brent crude standard.

But some commentators fear the downward spiral may only be halted if there is a rejuvenation in global demand, which has fallen and will need to recover if oil prices are to be revived.

They also claim major oil-producing nations will not slow supply any time soon because it is still profitable to keep production at the same levels.

Mike Allen, chief investment officer at Momentum Global Investment Management, said without a reaction from the supply side “prices could fall further from here”.

He said the cost of extraction levels for the Middle Eastern producers, of between $20 to $35, represented a theoretical floor.

However, he said it was “unlikely” oil would reach those lows. He predicted the price could move towards $40 a barrel by the end of the first quarter, which is historically a period of low demand.

Matthew Tillett, UK equities manager at Allianz Global Investors, said in the current “oversupply” market dynamic, “the price can almost go anywhere” and it was futile to predict short-term movements.

With the major oil nations committed to pumping oil in order to generate necessary revenue for their economies and companies unlikely to halt current production, experts predict the negative trend in the oil price would have to be sparked by data showing demand from industries and consumers.

“We will see a low oil price until demand firms up,” said Eric Chaney, head of research at Axa Investment Managers.

Mr Chaney said he expected to see a pick up in demand with oil at its current level, but added it would take a while to feed through and he didn’t expect the oil price to rise considerably for two or three years.

However, the expected pick-up in demand may not happen. This is because some investors have interpreted the falling oil price as indicative of a prolonged period of low global growth, and therefore low demand for commodities.

Mr Tillett said his central investment view was that the current oil price was unsustainable, so he had been investing in stocks related to the oil and gas sector, which he thought would recover when the commodity’s price did.

But he admitted the main risk to his view was the possibility of a “demand shock”.

He listed the possibility of a recession in the eurozone and a more severe downturn than currently expected in China as two factors that could prevent the expected pick-up in demand, keeping oil at its current low level.

And Frances Hudson, global thematic strategist at Standard Life Investments, warned the deflationary effect of oil could lead to a downward spiral.

She said deflation could cause companies to defer spending, leading to lower demand and thus a lower oil price, which would lead to more deflation as the negative cycle continued.

How oil could dictate central bank policy in 2015

There is a lack of consensus about what the falling price of oil will bring, but one school of thought is it could force a radical rethink in central bank policies this year.

The reason for this view is the disinflationary pressure being created by the low price.

Several countries are vulnerable in various parts of their economies. Data released last week showed the eurozone had suffered deflation in December, while the US and UK are expecting to see declining rates of inflation in the coming months.

Axa’s Eric Chaney, head of research at Axa Investment Managers, said the fall in inflation meant the first interest rate hikes from the US and the UK were likely to be “postponed”.

Raising interest rates, a form of monetary tightening, has historically been a disinflationary action because it raises the cost of borrowing and makes new spending less attractive.

While the US and the UK may have to rethink their tightening measures, the disinflationary effects of oil could cause the eurozone and Japan to embark on further monetary easing policies than have already been enacted.