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Don’t bet on a rapid recovery for oil prices

By Myra P. Saefong

Published: Mar 18, 2016 2:49 p.m. ET

WTRG’s James Williams sees oil falling back to $30

WTI oil prices could fall back to $30, says James Williams of WTRG.

Gains for oil this week were impressive, but Friday’s slump in crude has helped support skeptics’ view that crude’s rocket rise isn’t sustainable.

West Texas Intermediate oil CLJ6, -2.14% CLK6, -1.27% traded lower on Friday after settling a day earlier at their highest levels of the year. April oil, which expires at Monday’s close, dipped under $40 a barrel on the New York Mercantile Exchange.

The “crash” in oil prices was “linear, but the recovery will not be,” said analysts at Bank of America Merrill Lynch, in a note Friday.

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Oil has lost more than half its value since mid-2014. Still, they were poised Friday to tally a five-week gain of roughly 35%.

Crude prices have climbed “on growing hopes that the oil market is going to rebalance itself because of strong demand and a drop in supply given the noticeable idling of oil rigs in the U.S. in recent months,” said Fawad Razaqzada, technical analyst at Forex.com and City Index.

The latest data from Baker Hughes BHI, +1.35% shows that the total number of active U.S. drilling rigs has dropped to their lowest level on record. On Friday, Baker Hughes said total U.S. rigs fell 4 to 476. The U.S. oil-rig count edged up by 1 to 387 after 12 weeks of declines.

Domestic supplies of crude, meanwhile, have been rising over the last five weeks. The Energy Information Administration pegged total U.S. crude inventories at 523.2 million barrels for the week ended March 11. They’re at “historically high levels for this time of year,” the EIA said.

Market needs an output ‘cut’, not a ‘freeze’
The prospect of a deal to freeze output between Russia and the Organization of the Petroleum Exporting Countries has also given oil a boost, Razaqzada said.

Oil producers plan to meet on April 17 in Doha, Qatar to discuss limiting output, raising hopes that producers will work together to find a way to ease the glut of global supplies and boost prices.

However, the “goal” of the April meeting is, with the exception of Iran, to “have everyone put a cap on production,” said James Williams, energy economist at WTRG Economics.

“That is not bullish because at current production, the world is oversupplied by 1.5 to 2 million barrels a day,” he said. “Only a production cut is bullish and the nearest possible time” for a decision to cut would be during the next scheduled OPEC meeting in June.

“So far, price movements reflect more hope than reality,” said Williams. Given that, he expects WTI prices to “make another trip down toward $30.”

The Fed and oil’s rebalance
But not everyone is bearish on the outlook for oil.

Tim Evans, chief market strategist at Long Leaf Trading Group, said the gains for oil are sustainable because a sizable amount of weakness in the market over the last 12 months was based on the expectations that the U.S. Federal Reserve would be raising interest rates this year. WTI prices have lost over 30% from a year ago.

The central bank on Wednesday left interest rates unchanged and now forecasts two rate increases this year instead of an earlier estimate for four. Prospects for higher interest rates had lifted the appeal of holding dollars, dulling demand for dollar-denominated commodities.

Now the oil market has “to reprice that expectation, allowing energies to recover aggressively,” Evans said.

The mix of a weaker U.S. dollar DXY, +0.30% which is set for a weekly loss of over 1% in the wake of the Fed announcement, and strong demand for oil has given the market a “fundamentally strong outlook,” said Evans. “As of now, the market is not solely relying on a supply-side change in order to find direction.”

Instead, the market might be looking more closely for an overall balance.

Prices have apparently “started to reflect the prospect of tighter fundamentals in the future,” said Matthew Parry, senior oil analyst at the International Energy Agency.

Read: Oil rally is too little too late for cash-strapped producers

Parry said that the three years of a “heavily oversupplied market” could potentially end in 2017.

The closer the market gets to that time, “the less downside pressure there should be on oil prices,” said Parry.

http://www.marketwatch.com/story/dont-bet-on-a-rapid-recovery-for-oil-prices-2016-03-18?mod=MW_story_latest_news