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Is This Oil Rally The Real Deal? 6 Reasons It Could Be

By Ellen R. Wald, Ph.D.CommoditiesJun 13, 2016 01:25PM ET
www.investing.com/analysis/is-this-oil-rally-the-real-deal-200135438
Is This Oil Rally The Real Deal? 6 Reasons It Could Be
By Ellen R. Wald, Ph.D.   |  Jun 13, 2016 01:25PM ET
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Analysts are conflicted over whether oil’s latest push (now hovering around $50/barrel) is simply a result of temporary production disruptions or whether the glut is fundamentally easing. The current market conditions appear to be the result of a convergence of multiple factors, any one of which could reverse course and put the breaks on oil’s drive upward.

The key factors impacting the market right now are:

1) Summer Demand

Typically, oil demand rises over the summer months. In the United States, American gasoline consumption reaches its peak between June and August—typically requiring 90,000 extra barrels per day. Saudi Arabia is a small country, but it too relies heavily on its own oil to power for basic services (which is why it invests in domestic renewable energies such as the new wind power deal with General Electric (NYSE:GE). In Saudi Arabia alone, demand for energy to run air conditioners in the summer months can use an extra 0.9 million barrels of oil a day. This seasonal demand growth happens to have coincided with several supply disruptions this year.

2) Asian Crude Oil Consumption

Chinese crude oil demand remains strong, but not because Chinese consumption is continuing to grow. Most of the growth seems connected to the fact that China is exporting significantly more refined products—especially diesel. In other words, China is buying cheap crude oil, refining it, and selling the resulting products to its regional trade partners. Whether this new export business can continue to support Chinese crude oil demand is largely dependent on the needs of its trade partners and may not be sustainable.

India, on the other hand, could be poised to become the next big manufacturing center. If the government’s “Make in India” campaign is successful, India could experience huge growth in demand for crude oil and refined products. The IEA expects Indian demand to grow from 4 million barrels a day in 2015 to 10 million barrels a day in 2040. OPEC seems to agree, and cited India as a source of demand growth in the future. However, these projections are largely based on growth experienced by China over the past decade and may not prove transferable to India’s economy since a variety of political and societal conditions differ.

3) Shale Oil Supply

This is a huge question mark in the equation. Many shale fields in North Dakota have been neglected due to the high extraction costs there, whereas shale oil in Oklahoma and Texas is thriving again. Rig count actually grew in the U.S. this past week, for the first time in eleven weeks. However, it is unclear if this new growth will make a difference in global supply numbers. At the same time, the number of bankruptcies in the shale oil industry continues to grow. This is compounded by asset sales to private equity companies that are not equipped to operate the oil rigs and instead pay the bare minimum to maintain them until they can resell them at a profit. The prevailing belief is that as the price of oil climbs, more shale areas will come back online. However, the reality is more complicated. The cost of production varies greatly by company, by geography, and even within a given shale area. This is a case of too many variables to accurately predict what will happen, particularly as the price of oil hovers on the edge of profitability.

4) Nigerian Supply Outages

The Niger Delta Avengers are still causing havoc in Nigeria. They recently rejected talks with Nigeria’s government and attacked another Chevron (NYSE:CVX) oil well. Shell (NYSE:RDSa) even stopped trying to repair a pipeline the group attacked months ago. It is unclear at this point if the saboteurs would be pacified by the old amount of subsidies the Nigerian government once paid them to keep quiet. Since the government seems unable or unwilling to crush them militarily, this conflict—and resulting production outages—will likely persist, at least over the next few months.

5) Iranian Supply Growth

On the other hand, Iranian production growth appears to be filling in for the decline in Nigerian production. Iranian oil production is close to 4 million barrels a day, and Iran claims it will continue to grow over the next several months. However, Iran has yet to attract real foreign investment in its oil and gas assets. The country has signed memoranda of understanding with Italy, South Korea, and Japan, but has not yet entered into firm agreements. This is largely because the Iranian government has not conclusively determined the terms for foreign investors—a controversial political issue in Iran. Iran claims it will announce the terms in June or July, but at this point, who knows?

6) Market Speculation

Actions by speculators always seem to amplify trends in the oil market. Will the number of new shale oil rigs scare speculators away from oil’s recent highs? Or will OPEC’s declaration that the market is “coming into balance” be a more powerful driver? Or speculators could seize on the fact that crude oil storage facilities are still at capacity and drive prices down. Volatility itself increases the opportunity for those who trade in crude oil to make a profit. Whether or not the fundamentals indicate that prices should be this high and continue to rise, speculators have ample reasons to move current prices.

Is This Oil Rally The Real Deal? 6 Reasons It Could Be
 

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Is This Oil Rally The Real Deal? 6 Reasons It Could Be

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Comments (8)
Bilderberg CEO
Bilderberg CEO Jun 17, 2016 3:52AM ET
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Since when was expensive energy a good thing that benefits society? . We are living in bizzaro world.
Do Deikins
DoRight Jun 16, 2016 1:35AM ET
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First paragraph, the word is brakes, not breaks.. Thanks for your insights into areas in which I have little current information - specifically Iran.
stuart smith
stuart smith Jun 14, 2016 2:59PM ET
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Academics make awful traders.
Gavin Mill
Gavin Mill Jun 13, 2016 10:23AM ET
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but but but she got a phd, she must be right
Kyle Restly
Kyle Restly Jun 13, 2016 10:23AM ET
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She has an opinion and an outlet. Take her words for what they are; another opinion. Between her opinion and a multitude of others, you should be able to create your own opinion and act (or refrain) as you see fit.
Brad Smith
Brad Smith Jun 13, 2016 8:53AM ET
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Thank you for your insights Ellen. I'm still not entirely convinced of the oil demand continuing its current growth rate. Economies around the world still look shaky and this will eventually translate to negative impacts on the oil demand. This is especially true for China as their economy is a story of pervasive weakness. China's economy never seems to have a consistent rally and it is anyone's guess to when their economy will finally stabilize.
Darryl Parvin
Darryl Parvin Jun 13, 2016 8:26AM ET
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#6. Are the banks buying oil futures to push the price up and save their client's from defaulting on Billions?
Kyle Restly
Kyle Restly Jun 13, 2016 8:26AM ET
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Apparently some hedge funds are.. . http://business.financialpost.com/news/energy/oil-at-us100-some-hedge-funds-are-betting-on-it?__lsa=7a6a-906b
Vincent Valentine
Vincent Valentine Jun 13, 2016 7:29AM ET
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this article is a perfect example why we should not listen to anyone on the net. previously, she posted bearish articles when oil is going up... now, she is posting a bull article when oil is going down... have you made up your mind yet Ms. Wald??
Danny Furman
Danny Furman Jun 13, 2016 7:29AM ET
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Exactly
follow trade
follow trade Jun 13, 2016 6:38AM ET
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its good to see that you are finding new reason to change your headless previous analysis. i think market is always ahead of you.
 
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