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Oil Prices Come to Life

24 February 2016 in Trading Ideas

Key Takeaways

  • Oil prices have climbed since last week on hopes that production cuts will reduce the current supply glut.
  • The sector's consumer agency has warned to not expect subdued prices forever.
  • Motifs mentioned: Black Gold, Shale Oil
  • Stocks mentioned:Whiting Petroleum Corp (NYSE:WLL), Exxon Mobil Corporation (NYSE:XOM).

We’re not exactly back to talk of $100 barrels, but crude oil prices have recently gotten off the mat and may still have room to rise.

On Monday, the price of oil briefly topped $33 a barrel – rising as much as 6% in one day — as speculation about falling US shale output and an ongoing stock rally has fed the notion that crude prices may be bottoming after a 20-month collapse.1

Prices began the week with a late reaction to US rig count data from the previous week. Industry firm Baker Hughes reported the US oil rig number fell by 26 to 413, marking the ninth straight week of decline, according to a Morningstar.com article.

Goldman Sachs said in an analyst note cited by Morningstar that the current rig count implied US production declining by 395,000 barrels a day between the last quarter of 2015 to the end of this year.2

“Annual average US production would decrease by 445,000 barrels a day year-on-year on average in 2016, down an additional 20,000 barrels a day compared to the prior-week estimate,” said the bank in a note.

According to an ANZ Research note, the decline in oil rigs is a reflection of efforts by US shale producers to reduce cash burn.

Whiting Petroleum Corp (NYSE:WLL) has said it is canceling plans to drill 20 wells at Bakken and Three Forks as low oil prices have been killing profitability in the region. Whiting owns 667,000 acres in the Williston Basin, but is in cost-cutting mode after already slashing capital spending by 46% in the third quarter of last year. It has also shelved plans for a pipeline in the region.3

Meanwhile, Exxon Mobil Corporation (NYSE:XOM) has announced that it has failed to replace production for the first time in 22 years. Late last week, the oil giant confirmed its reserve-replacement ratio fell to 67% in 2015, under 100% for the first time since 1993. It announced it holds reserves equivalent to 24.8 billion barrels, enough to continue production at current rates for 16 years. This is down from 17.4 years of reserves at the end of 2014, but still better than that of its peers, according to an article on OilPrice.com.

The sector also got a lift from a report this week by the International Energy Agency, the world’s oil consumer body, which confirmed what many of the sector’s players had already been saying. The IEA said US shale oil production could fall by 600,000 barrels per day (bpd) this year and another 200,000 bpd in 2017.4

However, the IEA also said it expects prices to start recovering in 2017, followed by a sharp jump in price as supply shrinks following the under-investment going on now by struggling producers.

Fatih Birol, executive director of the IEA, said: “It is easy for consumers to be lulled into complacency by ample stocks and low prices today, but they should heed the writing on the wall: the historic investment cuts we are seeing raise the odds of unpleasant oil-security surprises in the not-too-distant-future.”

Of course, there has been nothing unpleasant about the recent rise in oil prices for those investing in oil stocks. The Black Gold motif, for example, has increased 12.4% in the past month. In that same time, the S&P 500 has increased 2%.

Over the last 12 months, the motif has lost 27.1%; the S&P 500 is down 7.8%.

The Shale Oil motif has risen 10.9% in the past month, and has decreased 33.4% in the past 12 months.

Oil prices have been in a recovery mode since last week after Saudi Arabia and two fellow members of the Organization of the Petroleum Exporting Countries (OPEC), Qatar and Venezuela, agreed with non-OPEC member Russia to freeze output at January’s highs, according to Reuters.

But Iraq, a key member of OPEC, said on Monday it planned to raise production to above 7 million bpd over the next five years, and export 6 million bpd of that. Iran, OPEC’s fourth-largest producer, has repeatedly pledged to raise its output too to pre-sanctions levels.

OPEC Secretary-General Abdullah a-Badri said OPEC and non-OPEC producers might take “other steps” to reduce the global supply glut, and that he was willing to speak with US officials, Reuters reported.

The IEA expects global oil supply will grow by 4.1 million barrels of oil per day between 2015 and 2021, down from an increase of 11 million barrels of oil per day between 2009 and 2015.

It also expects investment in oil exploration and production to fall by 17% in 2016 following a 24% decline last year.

“Only in 2017 will we finally see oil supply and demand aligned but the enormous stocks being accumulated will act as a dampener on the pace of recovery in oil prices when the market, having balanced, then starts to draw down those stocks,” the IEA said.

In the short term that could mean continued volatility in oil prices. For longer-term investors, however, subdued supply may eventually mean oil under $30 a barrel will only be a reality for so long.

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Investments in commodity-related products, such as precious metals, agricultural products, and oil may be subject to greater volatility and liquidity risks than investments in traditional securities. Commodity-related products can be significantly impacted by underlying commodity prices, world events, government regulations, and economic conditions, which can dramatically affect the value of an investment.

  1. Barani Krishnan, “Oil ends up 6 percent on lower shale output bet, equity rally,” reuters.com, Feb. 22, 2016, http://www.reuters.com/article/us-global-oil-idUSKCN0VV01K.
  2. Jenny W. Hsu, “UPDATE: Oil prices higher after last week’s rig-count drop,” Morningstar.com, Feb. 22, 2016, http://www.morningstar.com/news/market-watch/TDJNMW_2016022231/update-oil-prices-higher-after-last-weeks-rigcount-drop.html.
  3. Matt Smith, “Oil Prices Rally On IEA Report,” OilPrice.com, Feb. 22, 2016, http://oilprice.com/Energy/Energy-General/Oil-Prices-Rally-On-IEA-Report.html.
  4. “IEA warns consumers of spike in oil prices,” bbc.co.uk, Feb. 22, 2016, http://www.bbc.com/news/business-35629420.