The Oil market could become more disorderly as oil prices try to find a floor around operating cash costs, suggesting a growing risk of WTI moving below $35/bbl near-term and Brent slipping to $40/bbl, according to BofA Merrill Lynch.The term structure of oil continues to weaken and inventories keep piling up. This frames the stage for lower prices in 1Q15. To find a floor, the oil market needs to see (1) non-OPEC supply curtailments, (2) OPEC output cuts, or (3) stronger global demand. At the moment, none of these seem to be materializing. If anything, an impending buildup in floating storage (i.e. oil stored in vessels) could even hurt the prospects of a 2H15 recovery, BofA Merrill Lynch said.

Global oil demand will ultimately react to lower prices. But our models suggest a 6 month lag and a limited response from OECD nations due to fuel efficiencies.

Incrementally China and India will have to deliver the bulk of the global consumption increase in 2015/16. Yet 50% of global oil demand growth in the last 10 years has come from oil producing countries, a worrying statistic as Middle East growth slows and Russia heads into recession. In sum, either production guidance for 2015 goes negative, global activity speeds up, or Saudi blinks.

Non-OPEC oil supply cuts will not come easy in the short-run, as operating cash costs sit below $40/bbl. True, investments will be put on hold as some of the world's output is challenged below $70/bbl in the long-run.

However, production guidance continues to point up in 2015 for most listed companies. Saudis could blink too and cut supplies. Much trumpeted financial reserves would last a lot longer at $70 or $80/bbl than at $20 or $30/bbl, price levels recently alluded to by  al-Naimi.

Yet Saudi Aramco could also increase output by 2.8 million b/d as US shale production shuts down, pushing Saudi's fiscal budget break-even oil price down by $22/bbl.
Source: BofA Merrill Lynch