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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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2017 – A Quiet Year For Oil?

Offshore rigs

After several years of turmoil, 2017 could provide investors with the mercy of a relatively quiet year for oil prices. There are reasons to be optimistic about prices going into the start of the year. The OPEC production cuts have shored up sentiment and set the stage for restrained production in the first half which could draw down oil stocks considerably.

Yet it’s not clear that oil prices will continue to rocket higher either. For one thing, many analysts are skeptical about OPEC commitment to cuts, while others point to the rebounding rig count used for unconventional U.S. production.

Put these factors together and 2017 could see oil struggle to make any serious gains while simultaneously being resilient to any serious losses. In particular, money managers as a group are very bullish on oil. Bullish investments from money managers on WTI prices going into January 2017 are triple what they were going into January 2016. Bullish sentiment is higher at this stage than any time since the oil price crash began almost three years ago.

Oil market sentiment in general appears to be more bullish now than it has been in years. That optimism is having different effects on different parts of the supply chain though. The OPEC nations have already started to see pressure coming off of them thanks to the pick-up in prices.

Middle Eastern oil companies reduced their borrowing in 2016 by 26 percent in large part because of the increased prices in the latter part of the year. The increase in prices helped to fund exploration and production programs without the need for additional borrowing. While industry was able to cut borrowing needs, many of the Middle Eastern nations themselves increased borrowing because of the holes created in their budget by falling oil prices.

In 2017 it’s likely that OPEC nations won’t need to borrow as much, and that borrowing by industry will continue to remain restrained. As financial pressures ease though, it may open the door to slow growth in production which in turn could limit the upside money managers are expecting in prices. Related: Oil Major Shell Plans To Shrink As Oil Rebounds

Oil should also see limited volatility next year because prices will be insulated from geopolitical risks. In past years, when many producers were pumping barrels all out, any supply disruption due to things like Canadian wildfires or Nigerian terrorism raised the risk of a short-term shortage often leading to price spikes.

With OPEC cuts largely baked into the price, it is unlikely that 2017 will see any more major supply cuts. Venezuela is perhaps the country which is most likely to see overall production decline, but those declines are going to be driven by a lack of investment and they will probably be gradual.

In 2017 because OPEC is aiming to operate below productive capacity, there should be plenty of slack available in the event of unexpected production issues. The typical spikes and dips in pricing from over or under production should be limited as a result this year.

Broadly speaking Wall Street analysts seem to agree with that view as well. Analysts are expecting crude prices to average $58 per barrel in the fourth quarter according to a Bloomberg survey. Dispersion among analyst forecasts is lower than usual as well.

Money managers and analysts have different views going into 2017, but neither group is forecasting a return to the oil price lows seen early last year and throughout much of 2015. Given that, investors should be breathing a sigh of relief and be ready to welcome a quiet year for black gold.

By Michael McDonald of Oilprice.com

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