Brent oil has breached the technical and psychological barrier of $60, while WTI inched up to $54. The bulls are relishing in the excitement of rising prices. But there's one pressing question: Is this rally sustainable? The bulls might have to proceed with caution.
Recent figures indicate a build-up of 856,000 barrels in crude inventories, with U.S production surging by 1.1 million bpd last week, to a total of 9.5 million barrels per day (bpd). Despite rising production, Baker and Hughes reported a fall in rig count by 4. The total rig count now stands at 737.
A driving factor behind the price rally was comments from Saudi Oil Minister Khalid Al-Falih, as he told the world that they will do "whatever it takes" to bring crude inventories back to normal and rebalance the oil markets. The comments were echoed by Crown Prince Mohammed bin Salman and Russian President Vladimir Putin. Subsequently, many observers and traders now think it's safe to bet on the rising oil prices.
Catch-22
When the members of the Vienna accord meet in November, many observers agree that they'll reach an agreement to extend the deal further than March 2018. Russia and Saudi Arabia are on good terms and the Saudi monarch's recent visit to Russia cements the fact that with both prime players of the deal on the same page, the extension is almost certain. The extension will likely translate into a price hike. The case could be made, however, that the markets have already discounted the impact of the extension, given its certainty.
Related: The Return Of Deepwater Oil
There's another side of this bullish development: its impact on shale production. Recently, there have been concerns regarding U.S. shale producer's profitability and growth, but the news of prices reaching and edging above $60 will certainly be music to the ears of U.S. drillers. This could result in greater production and hence amplify the supply glut.
The effect of shale growth and inventory reports after the deal is extended will be more potent than without it. Why? Because market sentiment and expectation play a momentous role in guiding the prices. In this case, the market will, evidently, expect inventories to drain. However, this balance between rising U.S. production and the Vienna extension will certainly have an impact on these expectations.
Back to Square One
According to Bloomberg, Rob Haworth of Bank Wealth Management in Seattle says, "My concern is what happens now that we're getting to these price-highs where we've typically seen a supply response." Related: Cautious Optimism Keeps Oil Over $60
Again, the two possible scenarios:
1) As the technical and psychological barrier ($60) has now been breached, we can expect to see a new floor which certainly will not be $60 but above $55.
2) Profit-taking, the abatement of geopolitical tensions in Middle-East, and as oil has surged to its highest since the 2014 price crash, the subsequent increase in supply from U.S. shale; all of these factors could give a sudden blow to the bears, plunging the prices once again.
In any case, the expectation of the extension of Vienna accord will continue to drive the prices up. What can happen is that, if, even after the extension, the inventories don't drain (as per expectation) and shale production continues to grow (which it will, given the price hike), the vicious circle that we have always talked about will set in-taking us back to square one.
Oil might be flirting with $60, but keeping in account the aforementioned factors, we shouldn't let the bullishness get the best of us. Some factors contributing to the rally are temporary, such as the developing situation in the Middle East. Others, however, leave us playing the waiting game.
By Osama Rizvi for Oilprice.com
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Osama Rizvi is an Economic and Energy Analyst with a special focus on commodities, macroeconomy, geopolitics, and climate change. He has written for various print… More
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