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Why $50 Oil Makes Sense

Shale Sunset

Crude oil’s fundamentals don’t support further gains from here. Oil markets are currently near an equilibrium, and the situation is likely to continue, unless the supply outages are sorted out.

The rumors about a likely production freeze by OPEC and Russia brought the oil bulls out from hibernation in February 2016. Since then, oil has been on a tear supported by a higher demand than previously anticipated, as well as various supply outages across the globe.

However, the current rally is at the critical resistance level of $50 per barrel (b), as shown in the chart below. Only strong fundamentals would justify an oil price increase from here. Can the rally continue higher toward the next level, at $60/b?

Analyzing the demand and supply situation will help determine if this is possible.

(Click to enlarge)

Demand

In its April Short-Term Energy Outlook (STEO), the EIA forecast oil demand to increase by 1.2 million b/d in 2016 and 1.3 million b/d in 2017. However, in the May STEO, the EIA revised the demand outlook higher for both 2016 and 2017. It now expects the global petroleum consumption to increase by 1.4 million b/d in 2016 and 1.5 million b/d in 2017. Related: Cash Deprived Venezuela Can’t Pay For Oil Imports, Leaving Tankers Stranded

On the other hand, JBC Energy, a Vienna-based consultancy, said that the global oil demand increased by 1.5 million b/d in the first four months of the year, reports Reuters.

Global consumption is propelled higher by the increased demand from China and India. The EIA expects Chinese oil demand to rise by 0.4 million b/d and the Indian demand to rise by 0.3 million b/d, both in 2016 and 2017.

On the other hand, the Oil Market Report (OMR) by the International Energy Agency (IEA) expects oil demand to grow by 1.2 million barrels in 2016. They expect higher demand from China, India and surprisingly, Russia.

The OPEC monthly oil market report for May has projected an increase of 1.2 million b/d in global demand in 2016. The OPEC report points to downward revisions for China and Latin America, which will offset the upward revisions for the rest of Asia.

The experts are divided on future demand growth in China. While a few believe that Chinese demand will rise, others believe that China will see lower oil demand in the future.

Chinese oil demand is expected to account for one-third of the total increase in global demand. However, many experts counter these claims, sighting the decreased fuel sales from Sinopec and PetroChina, the two Chinese oil giants. Related: Oil Prices Down As OPEC Fails To Agree Output Ceiling

Another report by Bank of America Merrill Lynch expects Chinese oil demand to fall short by 16.3 percent from IEA’s projections, reports Barron’s Asia.

Supply

Crude oil supply was affected due to militant attacks in Nigeria, unrest in Libya, and wildfires in Canada. This led to a drop of approximately 3.5 million b/d in oil production, which is the largest drop since 2003, reports The Wall Street Journal.

Though the Canadian supply disruption is likely to be sorted out soon, it is difficult to predict normalization in Nigeria’s and Libya’s supply.

Iraq, Iran, and Saudi Arabia plan to aggressively protect and increase their market share, which will counter the supply shortages. Similarly, a ruse in U.S. oil production due to the rebound in crude prices could sour bullish sentiments to a large extent.

After a sharp rise supported by various factors, the oil markets are approaching equilibrium close to the $50/b mark. Unless the supply outage issues are sorted out, oil bulls can breathe easy. However, if signs point to an increased production from OPEC and the return of shale oil drillers, oil prices will quickly correct to the low $40/b levels. Oil fundamentals are evenly balanced currently—we need to wait and watch to see which side it tips over.

By Rakesh Upadhyay of Oilprice.com

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