If you follow the energy markets at all, you already know that crude oil is enjoying an epic price rally. In mid-July of last year, benchmark West Texas Intermediate crude was trading at $45 per barrel. Six months later, WTI has zoomed to $64 per barrel: A heady 40% advance, which makes the stock market look positively pedestrian by comparison.
So, what gives? And more importantly, can the rally continue?
A host of factors have collided to push oil prices higher. For starters, OPEC is delivering on its promise to pump less crude and tighten the global market. Data from S&P Global Platts shows that, in December, the oil cartel actually pumped below its quota. That’s mostly attributable to a steep production decline in Venezuela, which is in the grips of a full-blown economic crisis.
There’s also the weaker U.S. dollar. Because most oil contracts are denominated in dollars, it takes more of them to buy a barrel of oil when the buck loses value relative to other currencies.
And perhaps most importantly, economic growth is picking up both in the U.S. and around the world, which points to higher oil demand ahead.
Whether prices can keep climbing will hinge largely on whether stockpiles of crude keep falling because of heavy demand and restrained OPEC production.
After setting an all-time high last March, America’s stored crude oil supplies have dwindled. That trend is accelerating, and at a time when refineries normally slow down for winter maintenance. That hasn’t happened this season, says S&P Global Platts Oil Futures Editor Geoffrey Craig. Instead, refineries have been running at full-tilt to churn out gasoline and other fuels. Why? Because of heavy demand for heating oil amid the recent polar vortex that locked much of the country in bitter cold for weeks on end, he says. Assuming the weather moderates, Craig expects refineries to stop buying up so much crude, which should allow stockpiles to rebound. The question is: How sharp will the turn-around be?
If refiners slam on the brakes and crude starts building up in storage at a fast clip, look for oil prices to retreat. Conversely, a return of severe cold will keep them running overtime, which would further drain stockpiles and probably push prices even higher.
Meanwhile, keep a close eye on U.S. oil production. Weekly data from the Energy Department have shown small but steady increases in domestic production, and the government is projecting that production will rise to a new all-time record in 2018, eclipsing the mark of about 10 million barrels per day set in 1970. (The latest DOE data peg current production at 9.75 million barrels/day.)
Will U.S. energy firms open the oil taps further in 2018? So far, the rally in oil prices hasn’t spurred additional drilling, at least according to the widely followed “Rig Count” survey published by Baker Hughes. Back in early July, when West Texas Intermediate crude was trading for $45 per barrel, there were 763 rigs drilling for oil in the U.S. Today, with WTI at $64 per barrel, there are only 747 rigs running. That supports claims from several energy companies that they are cutting their capital budgets to focus on turning a profit instead of spending heavily to goose production. Investors in the sector have applauded that cautious tack.
But if oil prices continue climbing, look for some companies to throw caution to the wind and “drill baby, drill!” That would unleash an even bigger supply increase than the DOE is expecting and weigh on prices. As a side note: S&P Global Platts’ Craig observes that energy companies are already rushing to lock in current prices via oil futures contracts. That might signal significant amounts of new crude coming to market fairly soon.
So, don’t bet too much on the oil rally just yet. High prices have a funny way of curing high prices. I look for WTI to pull back modestly this spring as refineries slow down their crude buys and American shale producers ramp up output. Of course, some sort of geopolitical shock, such as the shutdown of oil production in crisis-ravaged Venezuela, could always send the market soaring again. Or another cold spell could spur heavy demand for heating oil. But absent that sort of extraordinary event, the market looks due for a breather.