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Gregory Brew

Gregory Brew

Dr. Gregory Brew is a researcher and analyst based in Washington D.C. He is a fellow at the Metropolitan Society for International Affairs, and his…

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Does This Oil Price Rally Have Legs?

After a couple of miserable weeks, oil traders were finally offered some good news this week as prices started ticking back up, futures improved and bullish estimates began trickling in from analysts. Having endured a period of rock-bottom prices, benchmarks may be finally turning a corner, according to key market-watchers. But is the rally real, or just a temporary reprieve from long-term low prices?

Bloomberg reported on June 29 that a rally in prices was imminent, as over-supply concerns that have dogged markets for weeks finally began to recede. The key evidence was a drop in U.S. oil production, a sign that low prices were cutting into shale producers’ profit margins, while bad weather in the Gulf of Mexico and maintenance on fields in Alaska force more output off the market.

Oil production fell by 100k bpd in late June, down from a high of 9.35 million bpd. Domestic gasoline stocks are also down this week, a further sign that demand is cutting into existing supply, though total crude stocks were up 118,000 barrels according to EIA data.

Indications from OPEC that further production cuts were not being considered gave the market a boost of confidence: the cartel is apparently not concerned about low prices and feel that inventories will, eventually, start to fall.

Futures gained at the thought that a rally which began mid-week may extend into next week. A surge in domestic U.S. consumption next week for the Fourth of July holiday, a traditional high-driving period, could sustain a continued price rally and possibly lift prices above $47. Circumstances seem ripe for a traditional rally after the steep sell-off last week, as traders who sold hoping for lower prices may start to buy back into the market.

This news hasn’t entirely stifled the sense of lowered expectations tied to uncertain fundamentals. Despite a somewhat-optimistic tone and predictions that the worst of the price rout was over, Goldman Sachs cut their three-month WTI price forecast from $55 to $47.50. Goldman joined JPMorgan Chase and Morgan Stanley in cutting its price forecast, offering a mea culpa over its mistaken estimate that commodities would recover in 2017.

Related: The Offshore Boom To Break The OPEC Deal

The outlook of the bank, somewhat paradoxically, was “cyclically bullish with a structurally bearish framework,” as they noted OPEC cuts, high demand and declining inventories could send prices back up within the next month or so.

Goldman warned that OPEC producers exempt from the deal, notably Nigeria and Libya, could keep overall OPEC production high as they ratcheted up their output amidst internal strife. A confidential source told Bloomberg that Libyan output would soon exceed 1 million bpd. It’s already near a four-year high, exceeding 900,000 bpd, and the Libyan National Oil Corporation had announced its intended target of 1 million bpd by the end of July. If Bloomberg’s source is to be believed, Libya could reach this target even sooner.

Goldman also pointed to the elevated U.S. rig count, and warned that shale production would have to decline before the OPEC production cut deal expired at the end of the year. If American drillers hung on and kept pumping, it was likely that OPEC members would ramp up their own production to retain market share, preventing any kind of long-term correction in prices. There was still a good chance that inventories would fall by year’s end, but only if OPEC was able to cut more, correcting for Libyan and Nigerian output. Related: Is The U.S. Close To Achieving ‘Energy Dominance’?

Citibank has taken a much more bullish tone in its forecast, announcing that prices “have bottomed and are now set to soar.” According to numbers crunched by ZeroHedge, a price rally in the order of 23 percent would be in line with past experiences, indicating the price would reach $51 over the next six months, before the OPEC deal expired.

With OPEC determined to avoid further cuts, regardless of new production from the U.S., Libya and elsewhere, and inventories lingering at above-average levels, the spots of bullish optimism present at the end of this week look a little out-of-place. Long term factors look set to keep prices depressed below $50, barring major interruptions or lasting shut-downs in the American domestic sector. That looks even more unlikely after this week, with the Trump Administration throwing its support behind more drilling, more oil and gas leases onshore and offshore, and a long-term commitment to greater energy production.

Given these trends, Goldman’s prediction of sub-$50 prices looks fairly spot-on.

By Gregory Brew for Oilprice.com

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