Why Oil May Drop to $40 a Barrel

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Francisco Blanch, who is the head of commodities and derivatives strategy at Bank of America Merrill Lynch, says oil prices could bounce up and down in the near future. The direction, according to Blanch, will be mostly down in the near term. However, the moderately good news is that the price will find a floor at $40.

According to CNBC, Blanch said:

The bottom line is if oil falls below $40 per barrel on average, which is why I don’t see a lot of downside, we start to lose shale. In the context of OPEC not waging a price war, we need prices high enough to encourage some amount of shale drilling.

The open issue is who gets hurt and who gets helped if Blanch is right. The traditional answer is that OPEC and other countries that rely on oil exports are hit by a sharp reduction of money into their treasuries. Large-scale shale production is fairly new in the United States. There is a lesson, however, about oil prices and the ability of shale companies to operation. The last time oil fell toward $40, many shale producers had to shutter fields. Some went out of business.

The hands-down winners of these drops in oil prices are consumers and businesses that rely on oil, oil byproducts and gasoline prices to improve their finances. Gas prices are already at historic lows for the summer, with a national average for a gallon of regular at between $2.30 and $2.40. In some parts of the country, the price has fallen below $2. For households in which members have to drive long distances, discretionary income is freed up by low gas prices. That, in turn, should be good for U.S. gross domestic product, since about two-thirds of it is driven by consumer spending.

Blanch has momentum behind his forecast. Oil prices have dropped sharply so far this year. At the start of 2017, the price was above $55 a barrel. It has fallen to $45 more recently. Production may rise near term, which will press prices lower. That trend will continue until it is so low that many producers cannot afford to produce it.