Where Oil Prices Are Headed

In the most recent monthly web chat for subscribers of The Energy Strategist and MLP Profits, someone asked whether I like a particular energy company given current energy prices. My response was that there aren’t a lot of energy companies that I like with oil prices back below $50/bbl. But, after last week’s fear-driven dip following the release of the Energy Information Administration’s Weekly Petroleum Status Report, there are plenty of companies I like where I think prices are headed next.

Today I want to look at the major variables that are currently impacting oil prices, and those that will impact oil prices in coming months. But first, a quick review of how we got to this point.  

If you recall, at OPEC’s meeting last November, the cartel decided to address a global crude oil oversupply situation by reducing oil production by 1.2 million barrels per day (bpd). At the same time, OPEC secured an agreement from some major non-OPEC members – most notably Russia – that pushed the total amount of targeted cuts to 1.8 million bpd.

The oversupply had been caused by U.S. shale producers that had added nearly 5 million bpd of new oil production since 2010, and OPEC members that had added another 3 million bpd of production over the same time span. Ultimately the oversupply would sink the price of West Texas Intermediate (WTI) from $100/bbl to below $30/bbl.  

Oil prices quickly rallied by about 15% on news of the OPEC cuts, and up until last week WTI had hovered around $54/bbl. Traders had become extremely bullish following news of the OPEC cuts, and subsequent news that they were adhering to the cuts.

But when the herd is bullish, a little bearish news can quickly spook investors in the other direction. That happened last week when a bearish U.S. crude oil inventory report spooked speculators who had accumulated a net long position in crude of 525,000 contracts.  

Compounding this build in U.S. inventories were concerns that U.S. production has reversed course and is rising rapidly, along with fears that OPEC might not extend the production cuts at its next meeting. That would potentially lead right back to an oversupply situation. 

But are these legitimate concern for investors?

While this situation bears continued monitoring, the fundamentals still indicate a narrowing supply/demand picture in coming months. The U.S. production increase since bottoming last September is only perhaps a third of the total production cuts engineered by OPEC. The crude oil inventory build reported last week is localized in the U.S., and right now is primarily a function of refinery maintenance season. The International Energy Agency (IEA) has reported that OPEC’s production cuts seem to be working, with global crude inventories steadily coming down from record levels.

As a result, I view the current sell-off as short-term, and primarily fear-driven. Thus, this is a buying opportunity. But given that there are some potential developments that could drive the price of WTI on toward $40/bbl, investors need to be selective and choose companies that will survive at $40, and thrive above $50. Aggressive investors might choose to buy into one of the high-flying hydraulic fracturing sand companies that have corrected in the past week, but more conservative investors would be better served to buy one of the fiscally solid oil producers in our portfolios.

The biggest question hanging over the market is what OPEC will decide to do at its next ordinary meeting in May. I will discuss OPEC’s options and likely course of action in the next issue of The Energy Strategist.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

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