Oil investors seem to have grown more positive lately. Oil prices moved to $50 per barrel which suggests things are gradually tightening for the rest of the year. One thing remains unclear though, we don’t know how much farther oil prices can really move.
Bubble size represents market cap
FIGURE 1: PERFORMANCE OF OIL AND GAS COMPANIES
Description: Figure 1 highlights the performance of the oil and gas industry for the month of July 2017 (x-axis) and the performance of the 11 months prior to July 2017.
Recent data shows the largest weekly increase in net-long positions in oil futures contracts, and more so due to a built-in net-long position rather than a reduction in shorts. This data suggests that hedge funds, money managers, and investors are betting that crude prices will rise.
There are several reasons why oil prices have increased since May. First, the OPEC cuts are having an effect. The cartel is taking a 1 million bpd off the market. As time goes on, this will help decrease the supply-demand imbalance.
Second, US unconventional is showing signs of a slow down. There are a number of contributing factors for this including fear of a price downturn, caution from oil companies, and a bottleneck in drilling services. We can’t just look at a rebound similar to the one we saw in the first half of the year and extrapolate it to the future.
Lastly, another reason for an increase in oil prices was several OPEC members promising additional cuts, including the leader of the pack, Saudi Arabia, saying it would cut by another 600,000 bpd and specifically reduce exports to the U.S., helping draw down inventories.
Although the oil market is starting to look a lot tighter than it did in June, there are clues which can lead some to believe that the rally may be running out of room. Inventories continue to remain high in the US and other oil producing nations. Also, as shale slows down, the US expects to add more output. Then there are other producers outside of the U.S. like Nigeria that have barrels floating out there, adding to the supply.
The one variable that could upend all market forecasts is Venezuela. The South American country continues to remain in economic turmoil and is entering a new phase of crisis as of last week. If Venezuela’s exports are disrupted in any way, the ceiling for oil prices in 2017 could be higher than everyone expects.