Little Upside for Oil Prices
Don’t be fooled by the rally in oil prices. The underlying fundamentals for the oil sector remain bearish—unless you believe demand is suddenly going to surge and oil production will be drastically slashed around the world…
I don’t like oil as an investment until the underlying fundamentals shift to rising demand and lower sustained production cuts.
T. Boone Pickens, a long-time advocate of cutting the country’s dependence on OPEC (the Organization of the Petroleum Exporting Countries) oil, continues to believe oil prices are heading higher—not by a few dollars, but toward $70.00 a barrel by year-end
I’m not sure what kind of supply and demand analysis he is using, but the reality is that the numbers simply don’t add up for $70.00-per-barrel oil by year-end. Maybe by the end of 2018 it’ll happen, but the outlook for oil prices simply doesn’t look great at this time.
March West Texas Intermediate (WTI) oil surged above $34.00 last week, as traders bought on news that an agreement was reached by Saudi Arabia and Russia to cut oil production.
Yet it doesn’t mean the cut will materialize, as the countries also want other OPEC and non-OPEC countries, such as Iran and Turkey, to cut their production levels.
Conditions for Higher Oil
If the cuts do occur, it could give the oil complex a temporary boost. However, for oil prices to be sustainable, the laws of supply and demand must come into play.
In my view, the following conditions must be met:
- Oil production is cut by OPEC and non-OPEC countries: I’m not talking about a small cut, but something that is major, say more than 10%
- Idle U.S. oil rigs don’t come back online: this would offset the cuts stated in condition one
- Demand for oil rises: given the stalling in the global economies, I doubt this will happen to a degree that would be material enough to alter the supply and demand equation
- An intensification of the ISIS and Syrian conflicts: this could drive oil higher if it impacts the oil flow, though it would, of course, be temporary and simply a trading opportunity
As far as the rig count, higher oil prices could drive producers to restart idle rigs, which would be counterproductive to any OPEC cuts.
The fact there were only 451 U.S. oilrigs in operation for the week ended February 12 indicates the concern of rigs coming back online as oil prices rise. A year ago, there were 1,358 active rigs. In 2008, there was a record 2,031 rigs. (Source: “US Rig Count Falls as Both Oil & Gas Drilling Deteriorate,” Zacks, February 15, 2016.)
Demand Weakness Shows Little Improvement
What makes me think oil may be comatose for a while is the weak demand picture that likely will not significantly improve for a few years.
China’s economy continues to stall and many countries in Europe and Latin America are hemorrhaging.
The Organisation for Economic Co-Operation and Development (OECD) cut its global gross domestic product (GDP) growth estimates for the world, including Brazil, Germany, the U.S., and China. The OECD now expects the U.S. to expand at two percent this year and 2.2% in 2017.
China’s GDP is predicted by the OECD to grow at 6.5% this year, followed by 6.2% in 2017, as the growth normalizes to more reasonable and achievable targets.
The weaker global growth could continue to cap the upside in oil.
As a trader, I would be selling oil into strength, as the downside remains firmly in place.