Oil prices have risen again to the point that they are almost ready to match pre-Covid levels. There are two key drivers to this miracle, which no one predicted at first would be possible in this time period. The first is the slowdown in production by US producers and, of course, the millions of barrels of oil a day retained by the OPEC + cartel. The second is to recover demand, so far put light pressure on supplies and create a market condition known as “backlash”. A market condition where the future price of a commodity is higher than the current price or “spot”. This is bullish for long-term crude oil prices.
Another driver of the current oil price boom is the expectation of continued stimulus for the American economy. So far, this expectation has bolstered prices above the concerns raised by Friday Labor Report, suggesting that employment levels continue to affect the global recovery.
One aspect of the speed at which this recovery has occurred is the meteoric rise in the share of many energy companies, with ExxonMobil, (NYSE: XOM), and ConocoPhillips, NYSE: COP) surpassing the rest of the market in the last pair. 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 post WSJ article as saying: “The market definitely has some momentum! WTI will also go to $ 60. “
What is behind this movement?
As I commented in one Oil price item last week, one of the keys to this support for crude, is inventory writing, both in the U.S. and globally. As noted in this article, the Energy Information Agency (EIA) reports that the week of January 29th, inventories fell comfortably to the five-year average at this time of year. This represents a decrease of about 50 mm in storage barrels during this time.
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This drop in inventories has occurred at a faster rate than most experts thought possible and has helped create concern about future supplies that is now driving up prices. Certainly, we are not short of oil now, but the shift backwards from the contango is remarkable for the market.
As noted above, the key forces that initiated this move are production restrictions by U.S. producers, who are currently pumping about 2.4mm of BOPD less than a year ago and OPEC +. Last week OPEC announced a cumulative total of 2.1 billion barrels have been retained of 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 dropped by about 5% from its peak in 2020.”
The contractual gap in the first month widens
On Friday, the difference between the first month’s contract and the March 2022 contract widened to $ 5.16 per barrel. This is the largest premium for next month’s contract since the start of the pandemic.
This will have the effect of pushing prices back, as we have observed so far. Some analysts are concerned that this effect is exacerbated by the lack of long-standing contracts by airlines and other large buyers to cover their exposure to rising commodity prices.
Most think the current rally still has legs, as the backlash scenario offers traders an incentive to take oil out of storage and put it on the market, instead of paying for continuous storage.
Will oil prices go to the moon in 2021?
The two most used indicators for the future of American production are the number of drilling rigs that actively take advantage of new oil deposits and the number of tailings dumps that allow production to begin from narrow slate formations.
PrimaryVision data, graph by author
Higher prices stimulate increased shale patch activity, as shown in the chart above. Over time, if this continues, you will tend to prevent prices from rising too quickly, or it may even be possible to put a cap on your peak in the short term.
U.S. producers have repeatedly promised that the days of growth at any price were already in the past and their goals are to maintain current production levels or keep the rate of decline to a profitable level. Instead of growing, producers have focused on repairing the damaged balances caused by massive asset write-downs over the past two years and reward patient investors with higher dividends as margins widen. This commitment is about to get tested as the U.S. platform count approaches the 400 level.
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There could be some questions about these commitments, taken in the depths of the 2020 oil depression. U.S. producers have reduced equilibrium levels for most shale wells in the mid-$ 30s. , in what is called a level I surface. Those producers who extract oil from level I reservoirs make money by delivering them at current prices and a return to a market of more than 400 teams could indicate a flip-flop in their attitudes. .
Over the last year or so, the rate of new drilling has been lower than the typical annual rate of decline of 30-40% for shale formations. We are getting very close to a break-even point where this rate of decline will be overcome and new production will tend to increase inventory levels.
We could be on the verge of getting a short-term peak for WTI and Brent
Rising activity levels in the U.S. and around the world will tend to slow down declining inventory. Any signal that inventories are about to start rising will curb higher prices and may even lower them in the short term. As noted in my last article, there are also other factors that will tend to keep prices in the current range.
China’s economy had been shrinking as Western economies were roaring with the rise of the virus, in the control of a new outbreak. A recent Reuters article noted:
“Tens of millions of people have been shut down when some northern cities undergo massive testing amid concerns that undetected infections could spread quickly during the lunar New Year holidays, which are just weeks away.”
If this effect is prolonged, the demand for oil in China, which largely kept the price of oil falling into the cellar in 2020, could hesitate.
Iran is expected to begin testing current US economic sanctions such as The Biden administration has indicated its desire to restore the 2015 nuclear deal. Several million barrels a day could return to the oil market in a fairly short time if the appeasement of the Iranian leadership becomes again a U.S. negotiating policy.
Finally, the current containment of OPEC + will be more difficult to maintain as prices rise. Currently, 9.7 million BOPDs are withheld, in addition to Saudi Arabia’s “gift” of another million BOPDs. At its next meeting, on March 4th, In 2021 will likely focus on restoring retained production levels, to maintain market share.
In summary here, over the next few months, the market could receive mixed signals that would slow the pace of continued oil rises. But as the global economic outlook clears in the second half of the year, thanks to the pandemic being gradually defeated by vaccination, we believe the oil trajectory will continue to be higher. Some analysts, and in particular Goldman Sachs, are calling for a call Brent at $ 65 by the end of 2021. With WTI’s proximity to Brent these days, this could place the primary slate benchmark at more than $ 60 this year.
Your takeaway
Now the trend is upward for companies extracting oil and gas, as indicated by the current downturn in oil futures contracts. As noted, however, the oil market is a dynamic place where events can change the course of the commodity in minutes. I believe oil-related stocks remain reversible for those with a time horizon of more than a few months. Investors should look closely at high-quality companies with low production costs to gain entry points to establish new positions or add to existing ones.
By David Messler for Oilprice.com
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