Oil prices have recovered to the point where they are almost ready to match pre-Covid levels. There are two key factors to this miracle, which no one predicted in advance as possible during this time. The first is to limit production by US producers and, of course, the millions of barrels of oil per day retained by the OPEC + cartel. The second is the recovery of demand, which has so far put slight pressure on supply and created a market situation known as “downgrade”. A market condition in which the future price of a commodity is higher than the present or spot price. This is optimistic for long-term crude oil prices.
Another factor that determines the current rise in oil prices is the wait for continued stimulus for the US economy. So far this expectation has boosted prices compared to the concerns raised by Friday’s employment report, suggesting that employment levels continue to affect the overall recovery.
One aspect of the speed with which this recovery has taken place is the meteoric rise in the share of many energy companies, with ExxonMobil, (NYSE: XOM), and ConocoPhillips, NYSE: COP) outpacing the rest of the market in the last couple of months. The shares of each have increased by 10% since the end of January 2021.
John Kilduff, a well-known energy analyst, was quoted in a recent article WSJ article saying, “The market certainly has a certain momentum! WTI will also target $ 60. ”
What is behind this movement?
As we discussed in a Article OilPrice last week, one of the keys to this support for crude is the extraction of stocks, both in the US and globally. As mentioned in this article, the Energy Information Agency (EIA) reports that in the week of January 29of, stocks fell comfortably on average over 5 years for this time of year. This represents a decrease of about 50 mm barrels stored during this time.
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This decline in stocks occurred at a faster rate than most experts thought possible and contributed to concerns about future supply, which is causing prices to rise now. We certainly do not lack oil at the moment, but the transition to demotion from contango is noteworthy for the market.
As mentioned above, the key forces that initiated this move are the production restrictions of US producers, who are currently pumping about 2.4 mm BOPD less than a year ago and OPEC +. Last week OPEC announced a cumulative total 2.1 billion barrels were seized on the market since the peak of the Covid crisis in April 2020.
Another well-known energy analyst, Martin Rats of Morgan Stanley, was quoted by the WSJ as saying, “The amount of crude oil and petroleum products stored worldwide has decreased by about 5% from its peak in 2020.”
The contractual gap per month is widening
On Friday, the difference between the contract for the first month and the one for March 2022 increased to $ 5.16 per barrel. This is the largest premium for next month’s contract since the beginning of the pandemic.
This will have the effect of pushing prices down, as we have noted so far. Some analysts worry that this effect is exacerbated by the lack of long-term contracts by airlines and other large buyers to cover their exposure to rising commodity prices.
Most believe that the current rally still has its legs, as the downgrade scenario provides traders with an incentive to take oil out of storage and put it on the market, as opposed to paying for continuous storage.
Will oil prices go to the moon in 2021?
The two most used indicators for the future of US production are the number of drilling rigs that are actively exploiting new oil tanks and the number of tailings spreads that allow production to start from tight shale formations.
Data from PrimaryVision, graph by author
Higher prices stimulate increased activity in the shale patch, as mentioned in the chart above. Over time, if this continues, it will tend to keep prices rising too fast or it may even be possible to put a lid on their tip eventually in the short term.
US producers have repeatedly promised that the days of growth at all costs are in the past, and their goals are to maintain current levels of production or maintain a rate of decline at a profitable level. Instead of growth, manufacturers have focused on repairing the damaged balances caused by massive asset reductions in the last two years and rewarding patient investors with higher dividends as margins expand. This commitment is about to get tested as the number of US platforms approaches 400.
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There could be some questions about these commitments, taken in the depths of the 2020 oil depression. US producers reduced their profitability levels for most shale wells in the mid-1930s in what is called the level I surface. Those producers who extract oil from tier 1 tanks are making money on hand at current prices, and a return to a market of more than 400 platforms could signal a flip-flop in their attitude.
In the last year or so, the new drilling rate has been below the typical annual decline rate of 30-40% for shale formations. We are very close to a break-even point, at which this rate of decline will be exceeded, and new production will tend to raise higher inventory levels.
We may be approaching a short-term peak for WTI and Brent
High levels of activity in the US and globally will tend to slow stock declines. Any sign that stocks may be on the verge of starting to rise will slow down the brakes at higher prices and could even push them lower in the short term. As I mentioned in my last article, there are other factors that will tend to keep prices in their current range.
China’s economy was roaring back as Western economies struggled with the rise of the virus, in the grip of a new focus. A recent Reuters article mentioned:
“Tens of millions of people have been stranded as some northern cities are undergoing mass testing amid concerns that undetected infections could spread quickly during the Lunar New Year holiday, which is just weeks away.”
If this effect proves to be prolonged, the demand for oil in China, which has largely supported the price of oil falling into the basement in 2020, could sway.
Iran is expected to begin testing current US economic sanctions as well The Biden administration has indicated a wish to restore the 2015 nuclear deal. A few million barrels a day could return to the oil market in a fairly short period of time if calming the Iranian leadership becomes US negotiating policy again.
Finally, the current hold of OPEC + will be more difficult to maintain as prices rise. Currently, 9.7 million BOPD are withheld, plus the “gift” from Saudi Arabia of another 1 million BOPD. At their next meeting, March 4thof, 2021 will probably focus on restoring retained production levels, in order to maintain market share.
Summarizing here, in the next few months, the market could receive mixed signals that slow down the rate of continuous oil growth. But as the global economic image brightens in the second half of the year due to the gradually reduced pandemic of immunization, we believe the oil trajectory will continue to grow. Some analysts, especially Goldman Sachs, are calling for this Brent at $ 65 by the end of 2021. With the WTI approaching Brent today, this could raise the main shale reference year by more than $ 60.
Your takewayway
The trend is now optimistic for oil and gas companies, as indicated by the current scenario of downgrading oil futures. As mentioned, the oil market is a dynamic place where events can change the course of the commodity in minutes. I believe that oil-related stocks remain investable for those with a horizon of more than a few months. Investors should look closely at high-quality, low-cost companies for entry points to establish new positions or add to existing ones.
By David Messler for Oilprice.com
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