Oil is officially back in a bull market even as a rising dollar is causing some profit taking early. The return to bull market territory comes as the market is seeing that the bearish arguments that kept oil prices under wraps turned out to be wrong. Let’s go over why oil prices have returned to bull market territory.
Rising Global Demand
The adage that low prices cure low prices. Oil bears all year have been skeptical of oil demand. In fact, reporting agencies like the International Energy Agency warned that demand would not be strong. Yet, they had revised their figures and now predict that oil demand will climb this year by 1.6 million barrels a day ,the most since 2015 of stronger-than-expected consumption in Europe and the U.S. They may have to estimate that number higher after a report by OPEC Secretary Mohammed Barkindo, that told the Financial Times that crude exports from OPEC to Asia were expected to rise by 7.5 million barrels a day between 2016 and 2040, to 22 million barrels a day.
OPEC/ NON-OPEC Cuts
Despite market doubts, it is clear that after some time that the historic OPEC/NON-OPEC production cuts have helped balance the global oil market and has succeeded in reducing the oil glut. Many tried to laugh off the cuts and said that there was no way that the agreement would hold. Yet, that was an incorrect assessment as they doubted OPEC and mainly Saudi Arabia’s resolve to remove supply. Instead of the deal falling apart, OPEC and Non-OPEC made history with the best compliance to a production cut deal in history. Currently, OPEC and NON-OPEC compliance is above 100% capping off its best behavior ever. While there may be some problems maintaining that rate, the fact that many producers can’t raise production that much more and rising oil demand may make compliance less of an issue.
Unrealistic Expectations for U.S. Shale Production
Just last June the Energy Information Administration(EIA) is excited about the surging U.S. oil rig count made a bold prediction that U.S. crude oil production would reach a record annual average of 10 million barrels a day in 2018, blowing away the previous record of 9.6 million barrels a day in 1970. Yet, because reality is setting in and the EIA had to twice reduce their outlook for demand because the shale output did not grow as expected. The economics of shale output was not making sense sub $50 and even as producers added rigs and production they were not making money. The EIA revised lower U.S. oil production for 2017 from 9.35 million barrels per day to 9.25 million barrels per day a 100k barrel a day decrease. EIA also revised lower 2018 U.S. oil production from 9.91 million b/d to 9.84 million b/d, a 70k b/d decrease.
There are major reasons why shale stuttered. The steep production decline rates of shale oil wells and the lack of completion of shale wells despite the sharp increase in rig counts. Many thought that there was a linear correlation with rising rig counts and increasing oil production but that is not the case. Shale oil wells were being drilled but not being completed as the drillers are running into a brick wall with logistics were not making money.
Shale oil, despite predictions, was not able to meet OPEC cuts barrel for barrel. On top of that, there is talk of billions of dollars in bad oil and gas loans that may not be paid back on the rising risk of loans to shale producers is drying up investment dollars.
Rising Geopolitical Risk
As the global oil market tightens, geopolitical risk factors matter more. A conflict with North Korea, for example, would be bullish as it would threaten oil supply routes and China’s oil refiners. The recent Independence vote. The Financial Times reported that oil “prices received a further injection of momentum after Turkish President Recep Tayyip Erdogan warned Iraqi Kurdistan that he opposed its independence referendum that passed on Monday, saying Ankara could shut off its main export pipeline and economic lifeline. “We have the tap,” Mr Erdogan said. “The moment we close the tap, then it’s done,” he added, though he stopped short of saying he would go ahead and block the roughly 550,000 barrels a day of landlocked Kurdish oil that flows to his country’s Mediterranean port of Ceyhan. Kurdish oil exports have soared since 2014, allowing the Kurdistan Regional Government to plan for an eventual push for independence from Iraq.”
The historic impact from Hurricanes Harvey, Ira and Maria may have a short-term bearish impact but a bullish long-term impact. Oil demand will surge because of the rebuilding effort that will take place. Rebuild entire cities will use oil and oil products like crazy and the demand destruction will be replaced with a rebuilding surge.
Tightening Global Supply
This has led to a tightening of global supply. There are many ways to measure that but many in the industry are suggesting that supply is tightening more significantly than the major reporting agencies are reporting. OPEC said that “Commercial oil stocks in the OECD fell further in August and the difference to the latest five-year average has been reduced by 168 million barrels since the beginning of this year; however, there remains another 170 million barrels of stock overhang to be depleted. Supported by the improving forward structure in the futures market, floating storage has also been on a declining trend since June.”