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Nick Cunningham

Nick Cunningham

Nick Cunningham is a freelance writer on oil and gas, renewable energy, climate change, energy policy and geopolitics. He is based in Pittsburgh, PA.

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Oil Prices: Collapse Now, Spike Later

Oil storage

Oil prices closed out the week sharply down, wiping out all the gains posted since the start of the year.

Surging U.S. shale production, along with broader financial turmoil, has clearly put an end to the bullish mood in the oil market. U.S. shale struck several blows against oil prices this week.

First, the EIA dramatically overhauled its forecasts, predicting U.S. oil production would hit 11 million barrels per day (mb/d) this year, rather than late next year. Then, on Wednesday, it revealed estimates that put U.S. oil production at 10.25 mb/d for the week ending on February 2, a staggering 330,000 bpd increase from a week earlier. Those weekly estimates are subject to revision when more data becomes available, but if those figures hold, it would point to a significant ramp up in drilling activity and new supply coming online.

As a result, it seems that, in the short run at least, U.S. shale has killed off the oil price rally, which saw WTI move from $50 per barrel in October to the mid-$60s per barrel by January. Brent saw a similar jump from the mid-$50s to $70.

But we’re now potentially moving into the next phase of this cycle, an all-too-familiar correction after prices have seemingly climbed too far.

This time around the downward swing could be aided by a rebound in the strength of the dollar. Typically, a weakening dollar pushes up oil prices, and the rapid run up in prices over the last few months occurred not coincidentally at a time when the dollar posted a steep decline. But the greenback has clawed back gains, particularly over the last week, with expectations of rising interest rates. Related: The Oil Bubble Has Burst. What Now?

"The dollar index got down to 86 [cents], crude got to $66," John Kilduff, founding partner of Again Capital, told CNBC. "[The] dollar index is now back over 90, crude's back down around $61, ready to break and I think fall back down into the mid-$50s here fairly rapidly."



Dollar Index (DXY). Source: Bloomberg

However, the tightening in the oil market has not been a mirage. Inventories are closing in on the five-year average. Goldman Sachs argues that inventories are probably already back at average levels, but it will take time before we know for sure because of data is published on a lag. “The rebalancing of the oil market has likely been achieved, six months sooner than we had expected,” Goldman Sachs said in a recent note, predicting Brent will hit $82 per barrel within six months.

It may seem a bit of a contradiction — on the one hand, the oil market seems poised for a price correction amid rising supplies, financial turmoil and overzealous positioning from hedge funds in the futures market. On the other hand, inventories are back close to average levels and some argue that OPEC could overshoot and tighten the market too much. Who to believe? Related: What’s Behind The Energy Stock Selloff?

In the short run, the bears are back as U.S. shale output is skyrocketing. There will likely be a short-term liquidation of bullish bets from hedge funds and other money managers, after building up a net-long positioning that became overstretched. That could add to the losses for WTI and Brent.

But a price correction doesn’t mean that the market will settle in at lower prices for the long haul. Demand is rising and OPEC will likely maintain high levels of compliance with its production limits.

Moreover, the severe cutbacks in upstream spending that began when oil prices initially collapsed in 2014 have yet to really be felt in terms of supply. Large-scale projects that received FIDs before the market downturn were carried through to completion, allowing new supply to come onto the market even as the industry made sharp spending cutbacks. But that pipeline of projects is now on the verge of drying up, which raises questions about the availability of supply next year and beyond.

“From next year onwards, we literally halve the number of projects and decline rates are picking up,” Amrita Sen, chief oil analyst at Energy Aspects, said on Bloomberg TV. “I do think there is a potential for spike … We’ve seen a huge amount of shale production growth, 1.5 million barrels per day, year-on-year in Q417, and still we are drawing stocks everywhere. That just shows you that we aren’t adding enough supplies elsewhere and demand growth is very high.”

Sen says the market won’t go back to the days of $100-plus, but “it could be a spike up to $90-plus in 2019. Yeah, absolutely we can.”

By Nick Cunningham, Oilprice.com

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  • Mamdouh G Salameh on February 12 2018 said:
    One thing you are right about is that global financial turmoil during the last ten days has led to the fall in oil prices. However, your claim that surging US shale oil production has contributed to the price fall is wrong because there is no proof for it.

    International oil experts, keen market observers and even some authoritative organizations no longer accept the US Energy Information Administration’s (EIA) word for it nor the International Energy Agency’s (IEA).

    An MIT Study published in December 2017 concluded that the US vastly overstates oil production forecasts and that the EIA has been exaggerating the effect of fracking technology on well productivity.

    What is more surprising is the claim by the EIA that US oil production could hit 11 million barrels a day (mbd) in 2018. The fact that US oil production between January and November 2017 grew at a far more modest monthly average of 1.3% according to the MIT study, indicates that the EIA’s weekly forecasts could very well be overstating US oil production between 700,000 barrels a day (b/d) and 1 mbd. More realistic projections for US oil production in 2018 and 2019 should be 9.06 mbd and 9.18 mbd respectively.

    Furthermore, claims by the EIA are becoming farcical by the day. They are now claiming that the United States will become a net oil exporter (self-sufficient in oil) by 2022. To achieve this, they stipulate an annual economic growth of between 1.5% and 2.6% between 2017 and 2050 with energy demand varying between flat and growing by 0.7%. If their projections for US oil production change from week to week, how reliable could their projections be 23 years into the future, namely 2017-2050.

    Once the global financial turmoil subsides, we will see oil prices trend upward towards $70/barrel and beyond.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • Disgruntled on February 12 2018 said:
    I think what's happened is that "Da Bears" have staged a strong 4th quarter rally (football reference, not financially related). I guess there were some technical considerations (dollar strength and long vs short, etc), but mainly it was the cheerleading section that convinced the market that "the glut" is back on.

    I'm afraid you fall into this category, Nick, with your usage of terms like "skyrocketing" for the increase in US oil production. That is a purely propaganda term and you should refrain from it. Dr. Salameh is correct in that the EIA and IEA are fairly discredited sources for accurate data, and those two agencies are now just about full-fledged members of Da Bears cheerleading squad.

    Or maybe it's closer to the Great and Powerful Oz, and they're having to resort to "Pay no attention to that Demand behind the curtain!"
  • John Brown on February 12 2018 said:
    The world is awash in oil, there is no reason for oil to be over $40 a barrel, and yet everyone wants the Glory days of $120 a barrel oil. OPEC/Russia have had to idle millions of barrels of production that is just sitting their ready to go, and while they do that U.S. oil and gas production is booming. With WTI in the $60s U.S. production has already hit 10.2 million BPD, way of ahead of forecasts, and will hit 11 million BPD by mid 2018, not 2019 as forecasted. If oil just stays in the $60s U.S. production will continue to rip, and if it actually moves into the 80s. Well the only way that is sustained is if U.S. producers collude to restrict production, and everyone knows that would be illegal. So if oil stays in the $60s and edges up into the $70s and $80 and the U.S. doesn't continue to expand production by million of BPD we will know the law is being broken, and if the U.S. hits 11 million in mid-2018, and prices go higher it will hit 13 in 2019. Is OPEC/Russia really willing to cut back, and would it work. The idea of prices in the $80s or higher seems to be based on the idea that the industry will artificially restrict the production of oil, both in OPEC/Russia and the USA, because as every article makes clear there is NO real lack of supply.
  • James Brown on February 14 2018 said:
    "Awash" in oil? There may be some room between $40 and $120 a barrel. Let's remember that oil is not renewable, at least not in our lifetimes and at the rate we are consuming it. Let's also remember that fracking is a new technology that is extracting oil from previously difficult to reach deposits; what happens when that option has been depleted? While fracking costs have been driven down they are certainly not very economical if at all at $40 a barrel. You are correct in noting that some oil has been sitting offline and it will be interesting to see what impact it has when it is brought back online; I suspect by then oil demand will have gone up. The two gentlemen that took time to write rebuttals taught me much about things I had not considered; I am grateful for this forum, in the past I would have just taken what the columnist had to say as fact.
  • Brett Ingham on February 16 2018 said:
    Gentlemen,

    I believe this article is spot-on. Be wary of John Kilduff's opinions. He seems to be a perma-bear, and if you had bet on his opinions from summer of 17 you likely would be broke right now. Oil is always going down no matter what according to JK.

    The salient question, which we all seek, is "World wide, what is the average cost of oil to produce 100M bpd this year, 101.5M next year, etc., etc. I don't know what that cost is...but it isn't as low as $50/b.

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