Has the Oil Price Bottomed?

Good morning,

Many investors are questioning whether last Friday’s rally in the oil price is a turning point in the price of the commodity. On Friday, Brent (the international crude benchmark) posted the biggest one day gain since 2009. Brent rose almost 8% on the day and closed above $50 a barrel after the US announced a significant reduction in the amount of rigs. In this article I will go through the arguments in favour of both a lower and higher price of oil.

Reasons in favour of a lower oil price

• U.S. oil production has continued to climb, reaching 9.21 million barrels a day in the week ended 23rd January, the most in weekly data since at least 1983.

• Although headline rig counts might look impressive, analysts at Morgan Stanley pointed out that much of the drop has come from low yielding rigs.

• OPEC (which accounts for about 40 percent of the world’s oil supplies) has no intention of cutting its target of 30 million barrels a day. More so that in January production actually increased to an average of 30.37 million barrels a day in January after Angola and Nigeria (two countries forming part of OPEC) increased their output. Supply from Saudi Arabia and other members remained steady with no sign of a reduction in supply.

• Two OPEC delegates, one from a Gulf producer, said they could not rule out oil prices dropping to as low as $30 to $35, due to weak demand combined with global refinery maintenance in the first and second quarters of 2015.

• Global growth remains sluggish. The IMF said it now expects the global economy to grow by 3.5% this year and 3.7% in 2016, a 0.3% downgrade from its previous outlook released in October despite lower oil prices.

Reasons in favour of a higher oil price

• Companies continue to cut costs which will result in lower supply in the longer term. ConocoPhillips, the third-largest U.S. energy producer, said that it was cutting its rig count. Chevron Corp. cut its drilling budget by the most in 12 years, suspended share buybacks and laid off workers. Drilling contractor Helmerich & Payne Inc. said it may cut 2,000 jobs after receiving 22 notices from clients terminating rig contracts early. This would result in a reduction in supply in the future.

• The reduction in the US rig count would also have an impact on supply. Nomura predicts $60/bbl for Brent crude in 2015 as US rig count slides. They also stated that rig count may decrease a further 30-40% this year. Furthermore, global oversupply of 1.5-2mln bbls per day can be eliminated if US output falls by 15-20%.

• Meanwhile, Russia’s limited access to capital and supply disruptions in Libya amid armed conflicts present upside risk for oil prices.

Opinion

I think that the substantial increase in the price of crude was more due to traders covering their short positions in lieu of the news rather than the actual news itself. In the short to medium term, I still believe that the price of oil will remain subdued.

Outside North America, not much has changed yet. OPEC countries actually raised its output in January by an average of around 160,000 barrels a day, as countries like Saudi Arabia and Kuwait continued to defend their market share.

Good day and happy trading!

Kristian Camenzuli