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Oil Price Rise Could Be Its Own Undoing

Higher crude-oil prices could encourage shale producers to ramp up output again

MARKETS STOCKS ABREAST OF THE MARKET

By NICOLE FRIEDMAN and IRA IOSEBASHVILI

March 13, 2016 8:15 p.m. ET

The slide in oil prices has paused after crude fell more than 70% from its 2014 peak. Now the question is whether the recent rise itself could spark another downward spiral.

U.S. oil prices are up more than 45% from a 13-year low in February, boosted by talks among Saudi Arabia, Russia and other major producers about capping their output.

A temporary reduction in global crude supply following outages in Nigeria and Iraq also helped buoy the market.

On Friday, the International Energy Agency said that oil prices may have bottomed out, and it forecast U.S. output to decline by nearly 530,000 barrels a day this year. The report seemed to support the market’s increasingly bullish mood, pushing U.S. oil prices up 1.7% to $38.50 a barrel.

But this rally could lead to its own demise, many analysts warn. Higher prices will likely encourage shale producers to ramp up output again, muddying any forecasts for shrinking U.S. supply. Shale wells can be drilled and fracked within a matter of months, much more quickly than other types of oil wells that can take years to complete.

“My concern is if the market surges right back to $50 a barrel…we just end up with another problem six months from now,” said Jeffrey Currie, head of commodities research at Goldman Sachs Group Inc.“You’d be taking a lot of risk entering this market early,” he said, because a rally could be self-defeating.

Stored supplies of crude oil and refined products need to fall from current elevated levels before any sustained rally can take place, Goldman said in a note on Friday.

ENLARGE
Oil’s sharp rise has been part of a broader commodities rally that has lifted everything from gold and copper to cocoa and lean hogs.

But as with oil, many investors say they are still looking for more evidence of a fundamental rise in demand for commodities or a significant drop in production to justify further price increases.

“We have moved too much on too little data,” said George Zivic,portfolio manager of the $250 million Oppenheimer Commodity Strategy Total Return Fund, who said he closed out positions in copper, aluminum and zinc last week.

Commodity rallies, from copper to cotton, often face this dilemma: Will a sudden surge in prices lead producers to crank up output and oversupply the market? Last spring’s rebound in crude prices shows how this can happen.

Crude prices rose 40% between mid-March and early May last year to as high as $60.75 a barrel after falling to as low as $43.46. Investors piled in on expectations that the plunge in prices would spur a quick decline in U.S. oil output. Retail investors tried to benefit from oil’s anticipated rebound through exchange-traded funds designed to track oil futures, as analysts called for prices to return to $70 a barrel by 2016.

But higher prices also allowed producers to lock in prices for future years and invest in new output. The number of rigs drilling for oil started rising again over the summer as companies rushed to turn on the taps and generate new cash flow.

Some producers told investors that because of cost savings, they could afford to bring new wells online with prices above $60 a barrel. By August, oil had fallen to new lows.

Cost reductions now allow companies to increase production at even lower prices. Chevron Corp. could drill 4,000 wells in the Permian basin in Texas that would make money at prices below $50 a barrel, and some of those would make money below $30, Chief Executive John Watson told analysts last week.

Chevron has 16 rigs in the region drilling wells that will come online in six to 12 months. “We think that those wells that are being drilled will be economic at the kinds of low prices that we’re seeing today,” he said.

The oil surplus may be easing compared with a year ago. U.S. production fell on a yearly basis in December for the first time since 2011, according to the Energy Information Administration. Global production dropped 0.7% in the first two months of this year, the International Energy Agency said on Friday.

But Iranian production is expected to rise this year by several hundred thousand barrels a day, analysts say, as international sanctions are lifted.

U.S. crude inventories are at their highest level in more than 80 years. Cushing, Okla., a key storage hub and the delivery point for Nymex crude futures, is holding 66.9 million barrels of oil, 92% of its estimated working capacity as of September, according to EIA data.

Traders “want to see the inventory worked down,” said Joseph Quinlan, head of market and thematic research at Bank of America Global Wealth and Investment Management, which manages $380 billion.

Write to Nicole Friedman at [e-mail] and Ira Iosebashvili at [e-mail]

http://article.wn.com/view/2016/03/14/Oil_Price_Rise_Could_Be_Its_Own_Undoing/