Why The Recent Oil Price Rally Is Unsustainable

Crude oil prices have risen by about 40% over the past weeks after falling to a six-year low. Spot prices for Brent for example, were US$62.82 per barrel on 11 May 2015, up from US$46.09 per barrel on 22 January 2015, Energy Information Administration (EIA) data show. While some investors mull over prospects, others consider it the beginning of a sustained price rebound. United States ― mostly shale ― operators, for example, have been gearing to restart operations after idling about 60% of drilling rigs over the past few months. Such optimism however, is not supported by current market fundamentals.

Crude Oil Prices - Brent, WTI

Demand

Global oil demand is unlikely to rise significantly in the near term. China, a principal driver for global energy prices is projected to see only a 3.1% rise in fuels demand next year, compared to 11% in 2010, after the 2009 price slump, according to the EIA. The country’s economic growth rate for this year is projected to be the slowest since 2008. Goldman Sachs Group expects the year’s growth in crude oil demand (1.5%) to lag that in supply (1.7%), with an oil balance ― excess of supply over demand ― of +1.2 million barrels per day (MMbpd).

In spite of the low oil price regime, global economic activity has been middling at best. In the United States, growth slowed in the first quarter while sales data for the month of April remained largely flat as households cut back on purchases of big ticket items such as automobiles, Reuters reports.

The International Monetary Fund, IMF, in its recent outlook holds that world economic growth will remain uneven with a greater chance of negative than positive shocks. The World Trade Organization, WTO, has also reported that the current recovery in world trade growth will be slow, and, of greater concern, very tenuous.

Supply

Large as the current global oil supply glut may be, some countries, particularly the Gulf producers, have been adding to it. Saudi Arabia, with one of the world’s lowest production breakeven prices and a current focus on market share has produced at more than 10 MMbpd for the second consecutive month. Brazil has also been ramping up production: according to a recent media briefing, the country’s state-controlled oil company, Petroleo Brasileiro SA which supplies about 80% of the country’s petroleum output from the subsalt region, has since February this year, broken its daily output record three times. More significantly, these countries are also expanding their respective production capacities; and this, to a large degree, will check any upward pressure on oil prices by mitigating any growth in supply deficit. The recent cutbacks in capital expenditure (capex) by many E&P companies due to the fall in oil prices, led some analysts to project that when demand begins to rebound, an oil price crunch will ensue, as a result of the inability of available supply to meet increasing demand. That projection may now appear unrealistic. In addition, a senior Iranian official earlier in the week said that the group, Organization of the Petroleum Exporting Countries, OPEC, is unlikely to cut output at its next meeting, which is scheduled for June.

Iran, in spite of sanctions, is managing to increase output from initial lows, and as expected deals with Russia and China come into effect, may return to, or even exceed pre-sanctions output levels.

United States producers, even with more than half of rigs idle, have still increased output albeit at a lower rate. This has been due to operational efficiencies including shorter-term operational cycles. Estimated production breakeven prices for 80% of tight oil capacity are between US$50 and US$69 per barrel according to IHS.

With such large supply capacities in concert with weak demand and a massive supply overhang, a rapid and sustained price rebound remains unlikely in the near term; except of course, a major supply center is threatened or is put offline.

Speculation

Market speculators often play a role in the price of commodities, and crude oil is not an exception. During the 2008 oil price crunch and financial crises, oil prices spiraled higher while the market was well-supplied. In describing the causative factors, Chris Cook, a former director of the International Petroleum Exchange wrote:

“…the principal cause of the financial crises and of the volatility are one and the same – to wit, the ‘leverage’ or ‘gearing’ derived in the former case by deficit-based credit creation by banks, and in the latter case by both bank credit creation and forward/futures contracts”.

With current fundamentals not quite supporting a sustained price rebound, the recent price rises may in part, reflect the position of some investors trying to avail themselves of a perceived price trough for the oil market. The tide however may have turned as their net-long positions on the West Texas Intermediate for example, have declined to a two-month low, according to data from Commodity Futures Trading Commission.


3 Responses to Why The Recent Oil Price Rally Is Unsustainable

  1. Kevin Matheson says:

    There is just too much capacity to make for any quick price rebound. It’s going to be “lower for longer”.

  2. Al Vance says:

    Even this recent rally has proved unsustainable.

  3. The accord cuts are just not cutting it.