In December 2014, oil was in the $40s and looking ready to plunge into the $30s. Oil markets blamed U.S. shale. Then they blamed Saudi Arabia for pumping oil like mad despite weak fundamentals. Russia, the biggest energy exporter in the emerging markets, watched its currency hit an all time low of 70 to 1. Dennis Gartman of the Gartman Letter said oil is going demonstrably lower.
“The trend is down, and we will be surprised by how far down prices can go,” he said on Benzinga on Dec. 19.
He was right. It was. On December 3, the July 2015 oil futures contract for WTI crude was priced at $68.32. It fell all the way to $48.62 on Jan. 9. The mid-40s seems to be the floor on American oil prices. They shot up quickly, and in two months were right back down again. They began their climb once more on March 19. Where does it go from here? Summer is approaching. Demand will rise in the U.S. Prices tend to go higher this time of year. Is that still the case?
On Friday, Barclays Capital's asset allocation strategist Keith Parker laid out seven reasons why oil was rallying. I'll give you five of them.
1. The oil market adjusted faster than expected.
Barclays' oil strategists have discussed various fundamental reasons for the rebound in oil, but oil markets are not out of the woods yet. BarCap did raise their oil price target due to the return of the risk premium from Yemen unrest, new supply outages and a worsening situation in Iraq. There's now reduced Saudi volumes in the market and lower natural gas prices that pose a risk to further upside. Many market participants continue to expect stock builds throughout 2015, meaning demand will remain stable. Supply and demand adjusted more quickly in the first half of the year, led by China and India. This kept prices higher than expected. Stock builds are still likely, but at a lower rate. Comparing Barclays’ forecasts of oil balances from late January to the most recent one, the average quarterly stock build was revised down from 1.25 million barrels per day 660,000.
2. OPEC market share edged higher.
A small increase in OPEC market share can have a sizeable effect on oil prices. As OPEC production, driven by Saudi Arabia, has remained elevated and non-OPEC supply growth has slowed, OPEC’s share of production rose 0.5 percentage points from the fourth quarter to the second quarter of this year. This explains some of the oil price move this year. Parker estimates this contributed to a 3.7% gain in oil prices, based on their proprietary pricing models.
3. Weaker dollar, stronger commodities.
The beta of oil prices to the dollar is 1.0 in the BarCap model, reflecting the fact that oil is priced in dollars. The trade-weighted dollar is down nearly 6% since the peak in March, lifting oil prices 6% by default.
4. Rise in speculative oil futures positions
Short covering and the return of the market risk premium has increased the Commodities Futures Trading Commission (CFTC) speculative positions. They are rising from the lows in late March to levels last reached in July 2014. WTI net speculative longs as a percentage of open interest rose from 9.4% on March 24 to 14.5% last week. BarCap models suggest that each 1 percentage point shift in CFTC positioning moves oil prices 0.9%. So the positioning move boosted oil prices another 4.7%.
5. The better-than-feared 2015 supply imbalance
That was worth about 18% for oil prices. Better-than-feared supply-demand dynamics likely played one of the largest roles in the oil rally.
With oil rebounding, the market is much less focused on the positive effects of lower oil. It is worth noting that despite this meteoric rise since mid-March, oil is still priced 42% below the average levels last June.
Past oil sell-offs saw oil prices get back to 85% of peak levels on average at this stage of the rebound. Only in 1986 and 2008 were oil prices at lower levels. The rebound off of a low base has been considerable, but oil prices
are still well below the 2014 peaks and oil market fundamentals are still weak, Parker wrote in a report to clients on Friday.
Meanwhile, supply is expected to far exceed demand and speculative positioning is again elevated. If the dollar resumes its uptrend later this year with Fed hikes, oil is likely to stabilize in the 60s.
