Crude oil prices were have hit a two-year highs. Despite the misgivings of some pundits who view oil simply as a means for making money from short plays, the global market has finally stabilized.
That means we’re now in the perfect environment to make some nice money with the presence of two crucial ingredients: a degree of predictability and low volatility.
WTI posted a price above $57 on Tuesday morning, with the consensus now forming that the next resistance level may be around $59.
Meanwhile, Brent (set daily in London and the more globally used of the two primary oil benchmarks) is trading above $63, higher than my predicted range for December 31 of $58-$60 a barrel.
This means that my next estimates – for what the market will look like at the end of the first quarter of 2018 – will forecast a higher price.
I expect the movement to continue incrementally. Each new ceiling provides its own resistance, especially when improving profitability entices additional production from significant surplus reserves.
Nonetheless, there are two essential reasons why the price improvement is taking place, both of which we’ve discussed on numerous occasions here, and both boding quite well for investment returns in the sector.
Oil Supply Surpluses Can Be a Good Thing
First, the elusive, long-awaited balance in the market is here.
As I have previously remarked, such an equivalence between supply and demand does not mean the oil market is moving into a “just-in-time” situation.
This has been a recurring and popular strategy to minimize costs in a range of manufacturing and delivery venues. The idea is that you only make and ship what’s needed when it’s needed, to avoid having to pay for large warehouses and manage inventory.
It’s a great idea if you’re making widgets.
But it’s not possible when it comes to a major raw material like oil. People do not use crude oil – they use refined oil products. And without oil supply in storage to allow for at-will refining, even tiny swings in the availability of oil would result in huge swings in the price of crude oil (and refined oil products) …
That could wreak havoc on whole economies. So, this balance requires a surplus in the market.
The key is to restrain the excess flow from available extractable volume from driving down prices. This is especially the case in the U.S., where the presence of huge shale and tight oil reserves has prevented an appreciable rise in price and, until recently, had fueled a decline.
However, at current levels, much of American production is entering profitability.
Now, not all companies will benefit. The cycle of mergers and acquisitions will continue, as will bankruptcies.
But companies with developed operations, with producing wells in low-cost development basins, and with manageable debt will be able to time production, thereby improving price per barrel at the wellhead (where the producer is paid) while stabilizing the broader market.
The days are gone when producers were forced to flood the market in a desperate attempt to stay in business. Prices at current levels allow surviving companies to plan production. That sustains a higher pricing range.
All of this has the net effect of raising prices.
But that’s not all…
Venezuela is on the Brink of Collapse
Remember, the oil price is set globally these days, not in the developed economies of North America and Western Europe. And demand is increasing faster outside the U.S. and EU than inside.
U.S. crude exports to higher priced foreign end users are now at 2 million barrels a day. American refiners already lead the world in the export of processed oil products.
Second, events elsewhere in the world are contributing to lowered supply expectations. The OPEC-Russia agreement to cut/cap production is working and will now be extended into next year.
In addition, as I foretold some time ago, it now appears Venezuela and its state oil company PDVSA will not be meeting debt interest obligations.
This will further fuel the financial crisis in the country, constrict access to working capital, and exacerbate a PDVSA production decline.
This will lead to increasing flexibility among other OPEC members to increase production without impacting the overall price. Related: What A U.S. Electric Grid Attack Looks Like
A few years ago, I never could have imagined that U.S. oil exports would surpass those of Venezuela. Yet that is what is taking place.
Geopolitical tension elsewhere is also increasing uncertainty. In cases such as the Persian Gulf and the South China Sea, this translates into concern over whether oil transit routes will be affected.
And that raises prices.
In the absence of actual events, traders peg prices on the expected costs of available barrels. In the current environment, they need to hedge at the higher level, effectively pegging contract prices to the anticipated costs of the most expensive next available barrel.
They then use an array of options and other derivatives to provide insurance.
Both of these main factors are causing a gradual rise in the floor of pricing ranges. It is the floor, not the ceiling, of those ranges that genuinely tells us the attitude of market players.
The floor tells us the price will keep moving slightly up.
That’s all we need to make money with targeted moves.
By Dr. Kent Moors
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