Oil prices have been steadily rising lately, and there are no indications that the trend will reverse soon. Prices for crude oil futures rose last week to the highest levels since mid-2015, and further indications of a continuing upswing in prices could take the spot price back to levels not seen since 2014.
While an increase in demand can provide an additional boost for crude oil prices, recent stocks data suggests that global surplus of oil is diminishing as U.S. production continues its rebound following Hurricane Harvey’s damage at refineries along the Texas coast earlier this year. From a supply perspective, this presents challenges for OPEC members as they attempt to balance demand with output restrictions while maintaining market share against U.S. competitors.
Analysts at Barclays believe that oil prices will remain elevated at least through the second half of the year. Furthermore, they think that U.S. shale producers will continue to face production challenges and are unlikely to significantly increase output over the next few months — even if crude prices were to go back down to below $75/bbl for a sustained period time as some have speculated about recently.
Crude oil futures:
From a demand perspective, an increase in production of large oil companies (FOMC) is likely to be meet by higher demand from non-FOMC sectors such as refineries, steel and chemicals. The U.S. Energy Information Administration reports that crude oil production has been increasing since June at a rate of about 120,000 bpd combined from the FOMC and non-FOMC sources — with the latter’s contribution disproportionately higher than that.
The number of available refineries in the U.S. has increase from under 6,000 on average to over 9,000 today in part due to the increasing number of fuels being blend into gasoline and diesel in the U.S. With so many refineries in operation and demand rising, it is not likely that the U.S. will see supply issues that would severely curtail production.
Castorseed gains
In the short term, both the European Union and Russian oil industries will see their dependence on OPEC imports decline in June after the latter agreed to increase production in the middle of the month. Announced output levels represent a return to OPEC’s October 2016 guidelines, with Saudi Arabia anticipating an increase of 50,000 bpd in June and Nigeria expecting to add 15,000 bpd at its war-torn fields.
Saudi Arabia is likely to see the largest increase in production and exports, as the country will see its own demand for crude decline during the Muslim holy month of Ramadan due to weather conditions.
High oil prices also bode well for the demand from non-FOMC sectors that tend to be more cyclical than large oil producers (which are less so). The chemical industry has had a particularly strong run recently, with its forward price-to-earnings ratio rising from 14.5 at its recent low in mid-2016 to 46.2 currently — similar to levels seen before the financial crisis.
What is the supply outlook for oil markets?
In April and May, U.S. crude oil production was roughly flat compared to the previous two months and supplies inventories have fallen by over 6 mb/d since early May as refineries recover after Hurricane Harvey.
What is the price outlook for oil markets?
Barclays analysts expect a steady supply and demand balance over the next six months. If they’re right, there seems to be little reason why crude oil prices should not trade comfortably above $70/bbl. That would take the spot price back to levels last seen in mid-2014.
Having said that, oil prices are not moving in a straight line as of yet. A sustained period of above $70/bbl could cause some traders to mark down current year prices as an extreme risk, but it might also lead to more investment in the sector. If this were to happen, there would be strong incentives for OPEC to increase production.
