Oil prices have fallen back to the point where they are almost ready to catch up with Covid levels. There are two important drivers for this miracle, which no one would have predicted early in this period. The first is the production porches by American producers and, of course, the millions of barrels of oil a day that are being withheld by the OPEC + cartel. The second is the recovery of demand, so far a slight pressure on supply and the creation of a market condition known as ‘decline’. A market condition where the future price of a commodity is higher than the current, or ‘spot’ price. It is strong for long-term crude prices.
Another driver for the current rise in oil prices is the expectation for continuous stimulus for the US economy. So far, this expectation has raised prices over the concerns that Friday’s Labor Report, indicating that employment levels will continue to drop overall recovery.
One aspect of the speed with which this recovery has taken place is the increase in the share of many energy companies, with ExxonMobil (NYSE: XOM) and ConocoPhillips, NYSE: COP outperforming the rest of the market over the last few months. of months. Shares of each have risen by 10% since the end of January 2021.
John Kilduff, a well-known energy analyst, was quoted in a recent report as WSJ Article as stated: “The market definitely has momentum! WTI is also going to target $ 60. ”
What’s behind this move?
Like me in a OilPrice Article last week, is one of the keys to this support for crude oil, stockpiling, both in the US and globally. As noted in this article, the Energy Information Agency (EIA) reports that it took place in the week of January 29de, stocks fell comfortably to the 5-year average for this time of year. This represents a decrease of approximately 50 mm barrels during the storage period.
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This decline in inventory has taken place at a faster pace than most experts might have thought and has helped create concerns about future inventories that are now causing prices to rise higher. We certainly have no shortage of oil at this stage, but the move to deterioration of contango is remarkable for the market.
As mentioned above, the key forces starting this step are production constraints by US producers, which are currently pumping about 2.4 mm BOPD less than a year ago, and OPEC +. Last week, OPEC announced a cumulative total of 2.1 billion barrels withheld from the market since the peak of the Covid crisis in April 2020.
Another well-known energy analyst, Martin Rats of Morgan Stanley, quoted the WSJ as saying: “The amount of crude oil and petroleum products stored around the world has decreased by about 5% since its peak in 2020.”
The contract gap in the first month is widening
On Friday, the gap between the first-month contract and the March 2022 contract widened to $ 5.16 a barrel. This is the largest premium for next month’s contract since the start of the pandemic.
This will lead to a decline in prices, as we have noticed so far. Some analysts are concerned that this effect is exacerbated by the lack of long-term contracts by airlines and other large buyers to hedge their exposure to rising commodity prices.
Most believe that the current rally still has legs, as the scenario of deterioration gives traders an incentive to take oil out of storage and put it on the market, as opposed to paying for continued storage.
Will oil prices go to the moon in 2021?
The two most commonly used indicators for the future of U.S. production are the number of drilling rigs actively tapping on the new oil reservoirs, and the number of frac distributions that could cause production to start from tight shale formations.
Data from PrimaryVision, chart by author
Higher prices lead to greater activity in the shale spot, as shown in the image above. If this continues, over time it will tend that prices do not rise too fast, or even be able to cover their ultimate high over the short term.
U.S. producers have repeatedly promised that the days of growth are at all costs in the past, and their goals are to maintain current production levels or to keep the rate of decline at a profitable level. Instead of growth, producers have focused on repairing damaged balance sheets caused by massive write-downs of assets over the past few years, and the rewards of patient investors with higher dividends as margins expand. The bet is about to get a test as the U.S. counter approaches the 400 level.
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There may be some questions about these commitments, which took place in the depths of the 2020 oil depression. U.S. producers have reduced their break-even levels for most wells in shale land to the mid-$ 30s in what is called Tier I area. Producers extracting oil from reservoirs in Tier I are earning money at current prices, and the return to a 400+ rig market could indicate a flip-flop in their stance.
Over the past year or so, the rate of new drilling has been lower than the typical annual decline rate of 30-40% for shale formations. We are getting very close to a balance point, where this rate of decline will be exceeded, and new production will cause inventory levels to rise higher.
We could approach a peak for WTI and Brent in the short term
Increased activity levels in the US and globally will reduce the further decline in inventories. Any sign that the stock may start to rise will cause higher prices to slow down, and may even cause it to rise lower in the short term. As noted in my last article, there are other factors that tend to keep prices in their current range.
The Chinese economy roared back as Western economies rumbled with the rise of the virus, in the grip of a new outbreak. A recent Reuters article noted-
“Tens of millions of people were in the locks because some northern cities are undergoing mass tests amid concerns that undiagnosed infections could spread quickly during the lunar New Year holiday, which is just a few weeks away.”
If the effect turns out to be, it is the demand for oil in China that has largely sustained the oil price fall into the basement in 2020, may falter.
Iran is expected to begin testing current US economic sanctions if the Biden administration has indicated a desire to reinstate the 2015 nuclear deal. Several million barrels a day could return to the oil market fairly soon if the reconciliation of the Iranian leadership becomes US negotiating policy again.
Finally, current OPEC + control will be more difficult to maintain as prices fall. Currently, 9.7 million BOPD is withheld, plus the ‘gift’ from Saudi Arabia, of another 1 million BOPD. At their next meeting, March 4de2021 is likely to focus on restoring restrained production levels to maintain market share.
In summary here, the market may receive mixed signals over the next few months slowing the pace of the continued rise in oil prices. But as the global economic picture brightens in the second half of the year, thanks to the pandemic that is gradually being repulsed by immunization, we think the trajectory for oil will remain higher. Some analysts, and especially Goldman Sachs, are asking for it Brent at $ 65 By the end of 2021. With WTI’s proximity to Brent these days, it could exceed the primary shale benchmark this year by more than $ 60.
Your takeaway
The trend is now strong for companies extracting oil and gas, as indicated in the current backward scenario for oil futures contracts. As noted, the oil market is a dynamic place where events can change the course of the product within minutes. I think oil-related stocks remain investable for those with a time horizon longer than a few months. Investors need to look carefully at high quality businesses with low production costs for access points to establish new positions, or to add to existing positions.
By David Messler for Oilprice.com
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