The Fuse

Oil Returns to $60

by Matt Piotrowski | October 31, 2017

Market sentiment has reversed course from earlier this year when OPEC was pronounced dead once again, and traders and analysts are now suggesting prices could move even higher.

Global oil prices are now back above $60 per barrel, the first time since 2015, and are up 35 percent versus their 2017 lows reached in June. Market sentiment has reversed course from earlier this year when OPEC was pronounced dead once again, and traders and analysts are now suggesting prices could move even higher.

The following factors have increased prices and are likely to continue to support the market.

  • OPEC’s production cut effectively tightened supply-demand fundamentals. The cartel and its non-OPEC allies enacted extraordinary output discipline, reducing production volumes in line with pledges made last year. Analysts and traders initially voiced skepticism over producers’ commitment to follow through, but it’s clear, almost a year into the cut, OPEC remains determined to establish a higher-price environment.
  • Petroleum inventories in the OECD have declined sharply, and are forecast to continue to fall in the fourth quarter. Excess stocks have dropped by 180 million barrels since the start of 2017. In the U.S., both crude and refined product stocks have drawn down dramatically. Crude and gasoline inventories have fallen by 15 percent from their highs earlier this year, while diesel supply is down 24 percent. Overall, U.S. total petroleum stocks are now below levels seen two years ago.
  • Demand remains strong and is beating expectations. The U.S. Energy Information Administration (EIA) sees demand rising by almost 1.35 million barrels per day (mbd) this year and by 1.6 mbd in 2018, putting further stress on the global oil market. In the U.S., demand is increasing thanks to strong economic growth, rising incomes, and relatively low pump prices.
  • Geopolitical risk is escalating. The market’s main geopolitical focus lately has centered on the tensions between Iraq and the Kurds. The Kurdistan’s independence referendum and Baghdad’s seizure of oil fields in Kirkuk have spurred some supply glitches and precipitate the chances of further instability. At the same time, the situation in Venezuela is not improving. The country’s oil company PDVSA said that over the weekend it made its latest bond payments, averting a default for now. However, Venezuela’s oil supply is still declining, having already fallen by some 800,000 barrels per day in the past few years.
  • Growth in shale is not meeting expectations. Rising costs and pressure from shareholders have motivated companies to become more disciplined. U.S. crude production is forecast to be approximately 9.24 mbd this year, lower than previous expectations and below the 9.4 mbd average in 2015. To be sure, the industry is in much better shape than a year ago, but it won’t likely be able to replicate the sharp growth that the market saw from 2012-15.
  • Speculators are betting on higher prices. The combination of supportive elements has motivated investors in the oil market to take long positions. Traders are in agreement that OPEC is more likely than not to extend its production cut throughout all of 2018, increasing upside potential for prices. Hedge funds and other investors have accumulated bullish long positions in crude and refined products of almost 1.2 billion barrels.

While the market is vulnerable to even stronger prices, a correction can’t be ruled out either. OPEC members could cheat on their pledges or agree on an exit strategy that lacks credibility, growth shale and other non-OPEC supply could ultimately offset OPEC cuts in 2018, and many speculators could sell at once. However, OPEC has changed not only fundamental dynamics of the oil market, but the entire narrative: There’s very little, if any, talk about “lower for longer”—the issues currently rattling the market are not going away any time soon.