Breaking News: An Oil Price Rally Is Likely | News Today

By Nick Cunningham / Oilprice.com

Oil prices seesawed at the start of the week before jumping close to multi-year highs on geopolitical concerns, with Brent hitting $70 and WTI at $65. However, geopolitical pressure is only able to influence oil prices to such a degree because the market is fundamentally getting tighter.

Ongoing declines in Venezuela and concerns about heightened tension between the U.S. and Iran have significantly raised the risk premium for oil, even as some short-term factors recently pushed up prices.

The weekly EIA report was a bit mixed. U.S. oil production jumped again by 26,000 bpd in the week ending on March 23, putting output at 10.433 million barrels per day (mb/d), yet another record high. Still, the report wasn't exactly bearish. Although crude stocks rose, they increased by a modest 1.6 million barrels, and much of that is largely the result of a big jump in imports. More glaringly, gasoline stocks fell sharply by 3.5 million barrels.

In other words, U.S. production is indeed soaring, but it doesn't appear to be swamping the market, at least as of now. A variety of analysts have argued that oil demand is so strong that the market will continue to tighten, even after considering the explosive growth of U.S. shale. "This year will be the eighth year of continuous growth since the Great Financial Crisis; and the seventh consecutive year of annual growth of more than 1 million b/d," Wood Mackenzie said in a note. "Our latest forecast suggests that demand will grow by 1.7 million b/d in 2018, the fifth-highest this century."

In fact, some of the recent weakness in oil prices lately can be chalked up to fears of a trade war, which could upset economic growth projections. "The biggest risk to oil demand's winning growth streak is a trade war undermining the global economy," Wood Mackenzie said. However, the uptick in oil prices at the end of this past week, some analysts say, are at least in part a result of those trade fears subsiding. "Worries about demand being affected by a possible trade war kind of receded," Gene McGillian manager of market research at Tradition Energy, told Reuters.

At the same time, some attribution for the oil price increase belongs to a rebound in global financial stocks after a recent selloff. "The equities market is rallying and that's lending support to oil," Philip Streible, senior market strategist at RJO Futures, told Reuters. The flat dollar also lent some support to crude.

With trade war concerns on the wane, and global equities on the rise, oil prices rebounded. While these short-term factors no doubt played a role in pushing up crude benchmarks, they are occurring against a backdrop of a tighter oil market. The surplus of OECD inventories is now below 50 million barrels, whereas it was above 300 million barrels a year ago.

Indeed, the IEA sees the oil market tipping into a supply deficit as soon as this quarter, and inventory drawdowns will pick up pace in the second half of the year.

"The voluntary production cuts are only playing one part in this," Commerzbank said in a note. "The involuntary production outages in Venezuela are weighing more heavily, as they mean that OPEC is reducing its output by considerably more than originally intended."

As long as OPEC keeps the current production limits in place, the oil market will continue to tighten, even after taking into account U.S. shale growth. And OPEC has even signaled that it is considering extending the cuts for another six months, pushing the expiration date to mid-2019. If they follow through on that, there is a pretty decent chance that there is a lot more room on the upside for oil prices.

Still, there are a handful of uncertainties that would completely upend any reasonable oil forecast. On the bearish side, if OPEC somehow abandons its cuts, begins a phase out sooner than expected, revised the deal to account for sharp declines in Venezuela, or members simply started cheating, then oil prices could slide significantly.

But, arguably, there are more upside risks. The most dangerous is the likely return of sanctions on Iran from the U.S., which could curtail a significant chunk of supply. Worse, the Trump administration could head down a dangerous road that ends in war. Meanwhile, Venezuela's oil production continues to fall off a cliff.

In short, because U.S. shale growth is already baked into the current oil market projections, the risk to oil prices is probably skewed more towards the upside due to the variety of geopolitical ticking time bombs.

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Breaking News: An Oil Price Rally Is Likely | News Today