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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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Three Factors That Could End The Oil Rally

oil rig

The bullish forces helping to push crude benchmarks up to their highest levels in years could be running into trouble.

There is a confluence of factors that conspired to push Brent above $70 and WTI to $66, but several of those could be coming to an end.

First, the dramatic weakening of the U.S. dollar over the past year, and especially over the past two months, has buoyed oil prices. Because oil is denominated in dollars, a weaker greenback helps lift demand – and thus, prices – for crude. The dollar’s role in driving the oil price was punctuated last week when Secretary of Treasury Steven Mnuchin offered some support for a weak dollar, comments he had to somewhat walk back. Oil prices surged after Mnuchin’s comments raised speculation about a change in the U.S.’s preference for a strong-dollar policy.

The steep decline of the dollar took a breather on Monday, which removed some bullish momentum from crude benchmark prices. Meanwhile, Iran’s oil minister expressed concern about oil prices rising too high, and Baker Hughes reported a large increase in the rig count, pushing prices down. During midday trading, WTI was down more than 1.25 percent and Brent was off a similar amount.

If the dollar begins to regain ground, it could kneecap the oil price rally. “Further pronounced strength in the greenback could threaten crude’s recent mojo,” Baird Equity Research analysts said in a research note. Related: Elon Musk Could Go Unpaid For A Decade

Arguably the largest factor fueling the rally over the past two months has been the substantial drawdown of oil inventories. That too may soon run its course. Forecasters such as the IEA and OPEC have long predicted that inventories would begin rising again in the first half of this year. Thus far in 2018, the markets seemed to have derived some confidence from the past few weeks of drawdowns, perhaps overlooking the prospect of a return to storage increases.

There could soon be a reckoning. Last week offered some early signs that the inventory builds could be upon us. API reported a surprise build of 4.75 million barrels for the week ending on January 17, a report that was offset by the slight drawdown from the EIA. However, a growing number of market watchers are expecting crude stocks to start rising in the near future.

“That’s the biggest reason why you are seeing pressure on crude -- it’s a function of the reverse correlation to the dollar,” Bob Yawger, director of futures at Mizuho Securities USA Inc., told Bloomberg. “There is the expectation among a sizeable amount of the energy space that there will be a storage build for the first time in eleven weeks.”

Finally, another important driver of higher oil prices in the past few months has been the speculative positions staked out by hedge funds and other money managers. I have repeatedly cited this phenomenon as a serious short-term bearish threat to prices, but so far the bullish bets have continued to climb.

However, the overwhelmingly one-sided positioning from major investors has not gone away. In fact, hedge funds and other money managers continued to break new records for the volume of bullish bets on crude oil. Related: Iraq To Comply With OPEC Cuts Despite Lifting Oil Export Capacity

If investors start unraveling some of these bullish positions, crude prices could see a sudden and sharp selloff. “Considerable correction potential has meanwhile built up for all these energy sources — which may provoke a marked price correction at any time,” Commerzbank said in a note, referring the extraordinary buildup in speculative positions.

The unwinding of bullish bets could accelerate if a series of worrying headlines emerge. It isn’t inconceivable that EIA weekly reports in the next few weeks start to show ongoing gains in U.S. oil production, while simultaneously reporting a rebound in inventories. That is particularly true if refineries start to cycle down or go offline for some maintenance, as is typical before warmer months. Up until now, the inventory declines have helped distract from U.S. shale growth.

To be sure, there are plenty of reasons why oil prices could continue to rise. OPEC compliance remains high. Deeper unexpected outages from Venezuela, Libya and/or Nigeria are entirely possible. Demand is still strong.

But the increase in oil prices in recent months has been turbocharged by a weaker dollar, falling inventories and speculative bets on rising prices. If those factors disappear, the oil price rally will face a test.

By Nick Cunningham of Oilprice.com

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  • Mamdouh G Salameh on January 30 2018 said:
    You are jumping the gun, Mr Cunningham. The slow decline in oil prices since yesterday is motivated by profit taking. The oil prices will soon resume their upsurge.

    As I keep repeating, the significant rise in oil prices since early December 2017 was overwhelmingly motivated by very positive market conditions which are projected to last all through 2018 and beyond.

    You concluded your article by saying that “the increase in oil prices in recent months has been turbocharged by a weaker dollar, falling inventories and speculative bets on rising prices. If those factors disappear, the oil price rally will face a test.”

    Let us analyse your claims one by one. Starting with the US dollar (the petrodollar), its value fluctuations upward or downward always push oil prices down. It is no secret that the United States has been for years using the petrodollar to manipulate oil prices in order to achieve geopolitical objectives. Raising the value of the dollar exerts a downward pressure on oil prices through reducing global demand for oil. Conversely, by devaluing the dollar, the actual purchasing power of the oil revenues of oil-exporting Nations declines against other world currencies forcing them to raise oil production to maintain revenue thus depressing the oil price.

    Another factor underpinning the oil price surge is the fact that the global oil market is re-balancing much faster and earlier than anticipated. The re-balancing is a result of strong demand for oil. A build in inventories again could happen in two ways: one a weakening of global demand for oil : second the usual claims by the lEA, EIA and API intended to arrest the oil price surge. But then the market has seen through their ploy.

    Speculation has the least effect on oil prices contributing less than 5% for the oil price rise.

    Based on the projections for the global economic growth and the world demand for oil, it is safe to say that the oil price surge is here to stay at least in 2018 and 2019.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • Disgruntled on January 30 2018 said:
    Technicals and dollar strength . . . whatever. It's always about supply and demand in the end. Demand is definitely going up, strongly. As for supply, I think the OPEC is committed to shoring up the price of oil. They have to because their budgets can't sustain the continued draining from their savings accounts year after year. That said, the American horizontal industry can either prolong the misery of the last three years or they can resist the urge to gluttony (a deadly sin I might add). Right now, they are their own best friend if they can just figure it out that it's better to sell less oil for more than more oil for less.

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