Why Oil Prices Will Keep Moving Up From Here

Why Oil Prices Will Keep Moving Up From Here

by | published May 18th, 2018

For a sixth straight week, oil has continued to lead the energy sector higher.

And for a good reason.

The combination of market dynamics and geopolitics have not only pushed both WTI (West Texas Intermediate) and Brent sharply higher, they’ve also instilled a bullish price mentality  Wall Street going forward.

As it stands, WTI is now above $71 a barrel, while Brent hit $80 yesterday – breaching an important psychological threshold.

Now, here in Oil & Energy Investor, we’ve spent the past few weeks discussing the factors pushing crude to these multi-year highs.

However, today I want to circle back around to something I call the “oil balance,” and the toll it’s playing in the current oil price environment.

Let’s jump right in…

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Supply vs. Demand

When we speak of an “oil balance,” I’m referring to a balance between supply and demand, which always assumes the availability of excess volume.

Oil requires available volume beyond what the market needs at any time to narrow the pricing range. Of course, too much excess volume will prompt prices lower, while the opposite will drive prices higher.

That ‘balance” is rapidly emerging and, in some regions, may have already arrived.

With supply meeting rising global demand (providing a necessary available surplus in the process, thereby offsetting any drive to a supply-led bout of instability), some “play” for additional volume has emerged.

While OPEC continues to toe the mark with production caps in its agreement with Russia, expanding production declines in Venezuela, Nigeria, Libya, along with languishing extraction rates in Mexico and Kazakhstan exist, they will allow space for selective U.S. production increases without a corresponding downward pressure on prices.

The restraint is so noticeable that, this morning, Saudi Arabia pledged to add additional exports to meet increasing demand, following a complaint from India about sufficient supply at an adequate price.

The Indian situation will be aggravated by the resumption of U.S. sanctions against Iran. Indian refineries are largely designed to use heavier Iranian grade crude.

However, it is at this point that a TV talking head would usually throw the American “monkey wrench” into the conversation….

A Crude Deadlock

The large amount of excess U.S. shale and tight oil extractable volume has long been thought to stymie any contraction in global prices.

And, for most of the slow recovery throughout 2016 and 2017, that appeared to be the case.

But matters have now changed.

Put simply; we are in a market environment that allows additional U.S. production without the expected push down in prices.

There are three overriding reasons for this.

First, as I have already said above, some significant international shortfalls in production are providing a space for additional volume while prices remain intact.

If anything, several of those factors – especially Venezuela’s situation – are becoming more acute.

Yet the remaining two factors are U.S.-based in nature, and have the greatest impact.

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America’s Energy Dominance

Despite the worldwide production picture, rapid rises in U.S. volume will not take place for domestic reasons.

There is little doubt that the U.S. will become the world’s leading oil producer, displacing Russia.

Already, American production levels are expected to reach 12 million barrels a day.

Yet under current conditions, that may put a temper on rapid pricing increases in WTI, but will not automatically change global pricing dynamics.

Remember, oil prices are set in demand locations other than North America or Western Europe.

That has been the case or some time and requires a more nuanced view of what the U.S. production flow genuinely is.

Which brings me to my second point.

While U.S. operators could easily ramp up massive production in a short period, they no longer need to shoot themselves in the foot.

At $70 a barrel, most of them are now running at a profit.

Further, unlike the desperate situation they found themselves in some three years ago (at the low point in the pricing cycle), they are making money and have access to lower-cost debt.

This latter point is not true for all producers, but there will always be a shakeout of the least efficient.

Nonetheless, the combination of these factors allows U.S. producers to keep extractable crude in the ground, thereby providing an insurance policy and maintaining price, while also offsetting concerns that a spike in aggregate production would threaten profit margins.

In short, we will see some additional U.S. overall volume.

Yet given the problems elsewhere in the world, the level of geopolitical uncertainty existing and a more realistic spread between WTI and Brent reflects the new environment.

The more important (and third) point directs attention to where the pricing is really determined.

This is international, not American domestic.

One of the most important developments in allowing an outlet for additional production has been the dramatic rise in U.S. exports to the higher-priced foreign markets.

This has allowed a drain off without adversely impacting domestic operators’ returns.

Well, this is reaching a limit.

The export levels have reached 2.5 million barrels a day, effectively meeting the cap available for U.S. export facilities.

These facilities are expanding – a major new focus is moving down the Texas coast from Houston and The Channel to Corpus Christi.

This move will provide some nice investment moves, but also is not going to happen overnight.

As such, the spread between WTI and Brent is likely to widen as more additional American oil remains in the U.S. market.

The main point, however, is a lowering impact of such production on the setting of prices.

The essential balance that is being struck also provides a more tempered approach by the U.S. producers themselves.

Maintaining the current price level is the key objective.

And that has already resulted in internal restraint when it comes to driving production levels up too much, too quickly.

The U.S. oil balance used to be about the naked survival of companies.

But not anymore.

Nowadays it only seeks to maintain revenue levels and returns.

Fortunately for us, that paints an even better picture for future investment prospects, which we’ll be happy to profit from going forward.



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  1. Alan isserlis
    May 18th, 2018 at 20:09 | #1

    A salient discourse.

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