The Good, the Bad and the Ugly: Where Will Oil Prices Go from Here?

Oil prices have been on a volatile rout from the beginning of the year. With the OPEC meeting in late September, Russia & Saudi Arabia production freeze deal, oil oversupply and concerns over global economy, it seems as oil will continue to attract traders attention. Towards the end of 2016, we gathered three analysts to sum up oil prices during this year and provide you with three different opinions into the last quarter of the year.

The Good: Not Too High, Not Too Low … Just Flat

(By James Hyerczyk)

Traders. Why the panic in crude oil? This year we’ve had liquidity, volatility and two lengthy trend trades. What more could you ask for? If you’re a daily chart watcher and a news player then you’ve witnessed the choppiness. However, taking a step back and watching the weekly chart pattern, you’ve seen a very tradable market.

There have been very few surprises this year with traders basically reacting to the traditional fundamentals (the now) and the speculative fundamentals (the future). What this means is that at times, the real supply and demand numbers have been driving the price action and at other times, speculation that a certain event will take place has driven the price action. So far, all I’ve seen is normal price action with the major players (hedge funds and money managers) trying to stick to the real numbers while the speculators have been reacting to “what could happen”.

Where Have Prices Actually Gone Since 12/31/15?

It’s been an almost perfect battle with each showing significant victories in their style of trading. The battle has been so balanced that if you draw a line from the December 31, 2015 close for the December 2016 futures contract, you will see that the current price as of September 1 at $44.34 is within $0.51 of last year’s close.

You don’t have to have a fancy charting package to determine that we are essentially unchanged for the calendar year. So does that mean we are a balanced market in terms of the traditional supply/demand fundamentals? No, since supply is still near record highs. However, it may be an indication that we are working towards that goal and likely to achieve it in 2017, barring any major surprises.

Also supporting the “good” idea about crude oil is the fact that the December futures contract has spent a considerably longer time “up” for the year than “down”. As of the week-ending September 2, crude oil has spent 13 weeks lower for the year and hasn’t finished a week lower for the year since the week-ending April 8. On the positive side, crude oil has closed the week higher for the year 22 times.

Going forward, I have to expect that there won’t be much deviation from this tendency with traders essentially using last year’s close at $43.83 like a pivot price, sometimes trading above it and sometimes spending time below. However, given the numerous attempts to balance this market through actual production cuts by U.S. producers and rumors of futures production freezes by OPEC and Non-OPEC countries, I cannot see any reason not to expect prices to remain steady around last year’s close the remainder of the year.

Rig Count Analysis

It is widely accepted by traders that the Baker Hughes rig count is a key indicator for the oil drilling industry. When drilling rigs are active, they consume products and services produced by the oil service industry. The active rig count acts as a leading indicator of demand for oil products.

Traders also use the rig count to predict supply and demand trends. At the end of December 2015, the rig count stood at 536. At its bottom the week-ending May 27, 2016, the rig count stood at 316. As of the week-ending August 26, 2016, the rig count was 406.

Without going into too much detail, the number of drilling rigs at this time of year is down 130 from the end of the year.

When December Crude Oil was at its low for the year at $34.06 the week-ending January 22, the rig count stood at 510. When the market was at its high for the year at $53.62 the week-ending June 10, the rig count stood at 328.

At its lowest the week-ending May 27, the rig count was 316 which meant that 220 rigs were taken off line from December 31. Since the lowest rig count, 90 rigs have been place back on line.

Although some will argue that only the most efficient rigs in the U.S. are producing, I still feel that overall production is going to continue to fluctuate with the market’s price swings. Therefore, producers are not going to let prices get too high or too low because they are going to continue to make adjustments to the rig count based on the price action.

If prices get high, more rigs will be put to work. If prices get too low, then rigs will be shut down. This action in itself is likely to hold prices steady and in a range.

Conclusion

Watching the day-to-day movement in crude oil prices suggests, at times, that there is no order in the market and that it is sometimes being manipulated by speculators, however, I see things a little differently.

I see a market that is being traded by trend traders working the fundamentals and speculators reacting to what could happen. This is how the market has maintained its balance this year. Basically, when prices get low, an event takes place that triggers a rally. And when it gets too high, something comes along to knock the market back down.

If the year ended today, I’d have to say that this is how most analysts would describe this year’s price action. So I have to conclude that barring any major shifts from this year’s “buy the rumor, sell the fact” theme, I can’t see prices deviating much from last year’s close at $43.83. So I have to conclude that prices will remain steady the rest of the year with the up and down swings balancing each other.

The Bad: Oil Prices Continue to Climb, Potential Damage

(By Christopher Lewis)

Recently, we have seen the crude oil markets rally rather significantly. This is true in both markets that I follow, the WTI Crude Oil market and the Brent market. Over the last couple of sessions, we have pullback a little bit but we are starting to show signs of support yet again. In other words, it looks as if we will continue to go higher for the time being.

The biggest problem of course is that energy prices factor into almost everything. The price of consumer goods will be affected, as the cost to transport them rises. In the world where we have several major economies struggling at the same time, and that central bankers are trying to add liquidity in order to increase spending, this could have a very negative outcome. This will be especially true in places like the United States and Europe.

With the recent stock market rallies that we’ve seen, the biggest fear that I have is that earnings seasons will be drastically influenced by it the rising cost of energy. This could put a very negative tone into stocks, and do real damage to major indices such as the CAC, FTSE 100, Dow Jones Industrial Average, and of course the DAX. Adding to that, the Nikkei 225 could get damaged due to the fact that it is full of companies that export to those countries.

With this being said, I do think that there is some hope down the road though. After all, the US dollar has been strengthening. Because of this, I believe that although oil will more than likely go higher, it won’t go drastically higher. Recently, there has been a lot of attention paid to the fact that there will probably be less drilling in 2017, due to the extraordinarily low pricing that the market had seen. This of course does major damage to various types of nontraditional drilling, and of course causes real pressures in countries like Saudi Arabia that need oil to be closer to $100 a barrel in order to keep up the social programs. In other words, I think what you are going to see is a real battle between OPEC and the value of the US dollar. Ultimately, as OPEC has proven itself to be very divisive in its drilling quotas, I believe the US dollar strengthening will win. I believe the market will go higher, but only for a relatively short time horizon.

The Ugly: Oil Prices Could Drop Unless OPEC Stands Together

(By David Becker)

OPEC oil ministers have called for an informal meeting which will be held in Algeria from September 26 to September 28. Producers are definitely concerned about high inventories and subdued demand and are considering reducing output in an effort to buoy prices. The issue for OPEC producers is that they need oil revenues to support their economies which has been under pressure following the 50% drop in prices since the middle of 2014.
Tensions are mounting for OPEC members, and there is not only anger amongst one another, but also at the new swing producer, the United States. Hydro-fracking U.S. producers, pushed U.S. stocks to their highest level on record, and despite robust U.S. gasoline demand, inventories of light sweet crude have remained robust. Production, on the other hand, has diverged globally.
While U.S. producers have been forced out of the market as prices fell below $30 per barrel, OPEC producers have been pumping oil at a ferocious pace during the past 24-months in an effort to reclaim market share from U.S. producers. This divergence is reflected in the import figures that are reported weekly by the Department of Energy.

U.S. Imports Surge

According to the Energy Information Administration, “U.S. crude oil imports averaged over 8.6 million barrels per day last week, up by 449,000 barrels per day from the previous week. Over the last four weeks, crude oil imports averaged 8.5 million barrels per day, 13.3% above the same four-week period last year.”
It is clear that OPEC is caught in the middle of a very difficult scenario. They have lost market share to a high cost producer, but technology has become advanced, allowing these producers to sit on the sidelines and wait for prices to rise before jumping back into the fray. In the past, OPEC could drive high cost producers out of the market, and then cap production bringing prices back up to profitable levels.

Ministers Begin the Jawboning Process

Saudi Arabia has been forced to jawbone in an effort to keep prices stable. Despite wanting prices to rise, they need to alert U.S. producers that they are likely to keep the peddle to the metal, and continue to pump oil at elevated levels. The Saudi oil minister was quoted saying “we don’t believe any significant intervention in the market is necessary other than to allow the forces of supply and demand to do the work for us.”

Inventories in the United States remain at record level, and over the past 2-weeks there is evidence that inventories are beginning to mount. The EIA reported that oil inventories are 523.6 million barrels, which are historically elevated levels for this time of year.
Demand is also strong, currently at 20.8 million barrels, but the U.S. is now moving out of the driving season, and into the heating season. Demand will begin to fall off, and if inventories continue to rise, which is the historical trajectory for crude oil stocks at this time of year, prices will decline, driving tensions for OPEC members, and create further pressure on their economies.