What’s Driving Oil Price Rally?

internatioanlrigcount

Oil prices plunged to their lowest levels in more than a decade earlier this year, but have since rallied by more than 70 percent from their February lows. Now oil is at a crossroads: the market is balancing, but not quickly enough. Oil traders are gaining confidence, but with oil trading at $45 per barrel, is the risk more to the upside or downside? Will the rally continue or will prices fall back again? And what about the long-term? Will today’s investment cuts lead to future shortages?

Brent crude oil for July delivery traded as high as $48.29 on Friday before dropping to below $47 a barrel on various reports that OPEC production had increased in April. The December futures contract traded as high as $49.65 on Friday, not a large spread, but as close as Brent futures have been to $50 a barrel in some time.

Part of the reason for that is that Brent prices well above $50 a barrel are not in Saudi Arabia’s interest. The kingdom has invested tens of billions of dollars in driving high-cost producers (mostly in the United States) to shut down production, and the effort has paid off. But if Brent rises much past $50 a barrel, the Saudis’ leverage diminishes, unless it also raises production to drive prices down again.

Neil Atkinson,  the Head of the Oil Markets Division at the International Energy Agency based in Paris responded recently to questions asked by oilprice.com: It can be argued that the sell-off to below $30/bbl was an over-reaction to the downside. The bounce bck to $45/bbl is partly explained by the strike in Kuwait, production interruptions in Nigeria, UAE and Iraq, and the growing perception that US shale oil production is declining. The bounce back is also due to the fact that investors are more forward looking than they used to be and the possibility of the market returning to balance around the turn of the year is a supportive factor.

He continues: The IEA has warned consistently that inadequate investment today could sow the seeds of a price shock tomorrow if there is a major change to the expected supply/demand balance. Towards 2020 there is the possibility that, if annual global oil demand growth were to exceed the 1.2 mb/d level forecast by the IEA and there was a geo-political event leading to a major supply shortfall, there could be insufficient spare production capacity to fill the gap. The resultant price spike would be detrimental for the world economy.

In conclusion… Current demand supply curve is not the only factor in oil pricing.  The decline in world rig count, the cancelation of many billion dollar plus projects by the majors, and the expected growth in future oil demand are all impacting the futures markets.  Maybe Mr. Atkinson is correct in his analysis that the $30/bbl pricing was an over-reaction to the downside.