Oil prices are finally building some momentum.
In a sign of a resurgence, oil prices are at their highest levels in weeks, with WTI jumping more than 6% and Brent more than 5% on April 6. The revival is uncertain and tenuous, but the rise appears more justified than it did back in late February.
There are a few reasons for the newfound bullishness in the oil markets. First, rig count declines are starting to slow. After several months of massive drop offs beginning in December 2014, rig count declines have slowed to a trickle. In the last two weeks, oil rigs fell by 12 and 11, respectively. So, instead of the oil patch losing 60 or 70 rigs each week, the pace of removal is down to about a dozen, raising the prospect that the industry is nearing the bottom. It may be hard to see on the graph below, but the very end of the line is starting to flatten out. At some point in the not-so-distant future, rig count losses will fall to zero and eventually rebound.
A second reason for the price rise is the increasing likelihood that production has also flattened and is approaching a decline. U.S. production fell in the last week of March by 36,000 barrels per day. But those figures will likely fall faster in the months ahead as shale wells that were drilled in 2014 start to see their output drop off. Shale wells suffer from a rapid decline after an initial burst of production. With wells drilled in 2014 set to decline this year and much fewer wells to replace the lost flow, overall U.S. production will start to drop soon.
Another reason for the price surge was due to the markets shaking off concern that Iranian crude will suddenly flood the market in the wake of the major breakthrough in negotiations with the West over its nuclear program. Iran hopes to ramp up production by an additional 1.5 million barrels per day, and that prospect caused a selloff in the days leading up to the framework agreement. But the markets overreacted. The tough task of finalizing the nuclear deal is still a few months away, and even if all parties can overcome hardliners in their respective countries, sanctions will not be lifted until after the International Atomic Energy Agency is satisfied with compliance, adding several more months of time. As a result it will likely take until 2016 at the earliest before Iran will be able to ratchet up its crude exports.
With the threat of a new flood of oil off the table for now, the markets have now turned to the fourth major reason oil prices are suddenly up: Saudi Arabia raised its price for oil going to Asia, for the second consecutive month. The official price raise reflects higher demand from Asian refineries, as Asian consumers have started to show demonstrable increases in demand due to low oil prices. Saudi Arabia sells its oil at a discount to the Dubai benchmark, and the price increase will narrow that spread.
The fifth reason for the surge in prices (which is in part an extension of the previous point) is that demand is starting to pick up in earnest, and not just in Asia. Refineries in the U.S. are running through crude at a rapid clip, helping to shave off some of the excess supply. Margins are fat, so there is a big incentive for refiners to process at full capacity. And the rate of refining will only increase in the coming months as the summer driving season begins, helping to ease the burden on oil storage.
Crude at the all-important storage hub of Cushing, Oklahoma is trading at a discount because inventories are piling up. As a result, more oil is getting piped down to refineries on the Gulf Coast in Texas and Louisiana. Cushing inventories fell by 300,000 barrels in the week ending on April 3, a sign that downstream demand is starting to put a dent in upstream supply. Whether or not the inventory drawdown is credible and sustained remains to be seen, but the data suggests that oil storage capacity may not fill up in the way that it originally appeared just a few weeks ago.
All of these factors point to an oil price rebound.
Courtesy: Nick Cunningham Of Oilprice.com
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