The oil market has been nothing if not volatile this autumn. At the beginning of September, the price of benchmark West Texas Intermediate hovered near $47 per barrel after spending most of the summer trading in the mid-$40s. Then suddenly, in the wake of Hurricane Harvey, WTI went on a tear, shooting up to $57 per barrel by early November: A tidy 21% gain at a time when oil demand tends to be low.
Had crude finally begun a sustained rebound after several years of depressed prices? Many oil bulls seemed to think so. Or at least, many did until earlier this week, when WTI dropped sharply after the International Energy Agency issued a prediction that global oil demand will grow more slowly next year than previously expected. Are oil prices just taking a breather before the next leg up? Or did this week’s drop mark the end of the autumn rally?
I asked two highly regarded oil market analysts that question, and got two very different answers. Stephen Schork, editor of energy investing newsletter The Schork Report, believes that the rally is “pushing up against the ceiling” and can’t last much longer. He attributes much of the price rise to speculators who have taken out long positions in oil futures, meaning they are betting heavily on continued gains. Many oil producers, he adds, are locking in today’s prices via hedging strategies: A sign that the sellers of the commodity don’t expect prices to keep rising.
Schork also notes that Saudi Arabia has been cutting its production substantially, perhaps in a bid to push up prices as it prepares for an initial public offering of part of Saudi Aramco, the state oil company. (Higher oil prices would make the Aramco IPO easier to sell to investors.)
Overall, he thinks WTI might top out at $60 per barrel. But if so, it’ll quickly retreat.
Phil Flynn, an oil analyst with trading firm PRICE Futures Group, thinks there’s room to run. Oil prices fell from $100 per barrel in 2014 to as low as $26 per barrel in 2016 because of oversupply. Now, Flynn notes, global inventories of crude oil are shrinking, which is exactly what OPEC was trying to accomplish when the cartel decided late last year to curb its collective output. The global economy is expanding briskly, which should prompt higher oil consumption. (Flynn thinks the IEA is low-balling global oil demand.) “I think we’re going to $60 per barrel,” he says; it’s just a matter of how quickly.
In the long term, Flynn sees prices rising beyond the $60-level as demand outruns supply.
Both make compelling arguments, but who is right?
I think the answer is a bit of both. It seems clear that, barring a sharp global economic slowdown, oil demand will keep growing. OPEC succeeded at reining in excess supply. Data from the IEA show that stored oil supplies stashed around the world’s developed economies have been dwindling for months (though they remain ample relative to the historic average). Strong demand and reduced supply usually push prices higher.
U.S. shale oil production is the wildcard for prices, however. American oil production has been rising steadily week by week, according to the Department of Energy’s data. Domestic output now stands at more than 9.6 million barrels per day, up almost 1 million b/d from a year ago. As I wrote last week, more and more of that crude is reaching the global market now that the U.S. allows oil exports. So, crude from Texas and other oil-patch states is just supplanting the oil that Saudi Arabia isn’t pumping, undercutting OPEC’s efforts to prop up prices.
This rally may be over. Late autumn is generally a time of weak demand in the U.S., the world’s largest oil consumer. The summer vacation driving season is in the rearview mirror. Domestic crude production looks set to keep rising. And Wall Street probably got too excited in bidding up prices. The market was due for a pullback.
But I think prices will gradually trend higher next year. WTI has averaged about $50 per barrel this year. I look for the average to run closer to $55 per barrel in 2018, though volatile day-to-day prices fluctuations will no doubt continue. I can’t rule out steeper gains, but they seem unlikely. Higher prices only serve to spur more drilling in places such as the Permian Basin of Texas. Many wells that might not be profitable at $55 per barrel start to look good at $60 or higher. And shale producers have shown they can ramp up output quickly when prices spike.
The U.S. oil industry looks well-positioned. Global oil demand will grow. OPEC will keep its output in check. U.S. production will ratchet up. And overseas demand for American crude is expanding. Simultaneously, U.S. operators are coaxing more oil from each new well in a bid to lower per-barrel production costs. Given all of that, prices won’t need to jump much to pump up energy sector profits.