The Fuse

Is Oil Poised for a Bull Run in 2017?

by Matt Piotrowski | January 03, 2017

At this time a year ago, the oil markets were getting pummeled. Anxiety over global economic growth, a hike in interest rates by the U.S. Federal Reserve, and a fight for market share among OPEC producers all conspired to bring about very bearish sentiment, eventually pulling oil prices below $30 per barrel. At the beginning of 2017, the situation is sharply different. OPEC’s willingness to cut, which brought about an agreement in late November, and implementation expected in the first part of this year have significantly altered the outlook. Oil prices reached $58 in London on Monday, with U.S. WTI hitting $55, both 18-month highs, before plummeting about 6 percent and finishing in the red for the session.

Along with OPEC removing barrels from the market, demand growth expected to remain robust around 1.3 million barrels per day means the stars could be aligning for a bull market to take shape throughout 2017, but it’s not inevitable.

Along with OPEC removing barrels from the market, demand growth expected to remain robust around 1.3 million barrels per day means the stars could be aligning for a bull market to take shape throughout 2017, but it’s not inevitable. Despite supportive news and hedge funds betting on higher prices, the market will likely remain range-bound all year—but with an unhealthy amount of volatility. The inherent skepticism of OPEC compliance and conflicting data points being released on a regular basis should create an uncertain environment and choppy trading.

The first trading day of the new year kicked off with supportive news that Kuwait and Oman will fulfill production cuts. On the surface, the reports were bullish, but only to a point. Analysts had expected these two producers to follow through with their pledges anyway, so the news could only boost prices so much. “Oman and Kuwait, along with Saudi Arabia, Qatar, and the UAE would have to be considered ‘most likely to comply’ and it will be output from other members that will tend to lag, limiting the overall reduction in supply,” said Tim Evans of Citi Futures in a report. Countries such as Iran and Iraq are the bigger wild cards with regard to their production levels going forward. Meanwhile, Libya’s output is moving higher to just under 700,000 b/d.

Bearish news from the greenback, shale

News from the financial world could also keep oil from rallying more. The dollar has gained considerable strength as of late, rising by more than 7 percent since early November, causing the oil rally to stall. If the greenback continues to strengthen, most likely as a result of monetary tightening, investors could flee oil, which is typically inversely correlated with the dollar. As of now, hedge funds and other speculators hold almost 342,000 long contracts in NYMEX WTI futures and options, the most since July 2014, when prices spiked to $115. This indicates the market is overbought and could see a large wave of investor liquidation, pushing prices lower.

U.S. crude output rose month-on-month in October, with major shale states such as Texas, Oklahoma, and North Dakota all seeing upticks. The country’s output is back up to 8.8 mbd, the strongest level since May.

Besides expectations for a stronger dollar, shale remains a big wild card and potential factor in holding prices in check. With the recent price rally, there have been numerous signs of life in the U.S. shale sector, which was hit hard when prices crashed. According to the latest revised data from the Energy Information Administration (EIA), U.S. crude output rose month-on-month in October, with major shale states such as Texas, Oklahoma, and North Dakota all seeing upticks. The country’s output is back up to 8.8 mbd, the strongest level since May, but still down 800,000 b/d from the high in the second quarter of 2015. More gains like those seen in October could be on the horizon—last year, U.S. shale companies reportedly raised more than $31 billion in 71 secondary stock offerings, allowing them to increase activity in shale areas.

Should the upward trend continue, gains in shale will offset cuts from OPEC, possibly helping the market see some semblance of stability. Based on an analysis of company guidance, U.S. shale production could rise by roughly 500,000 b/d year-on-year in 2017, one investment manager told The Fuse, noting that most forecasts call for only modest annual increases. The growth, however, may not occur until the second part of the year, leaving doubts whether shale can disrupt the oil market as dramatically as it did earlier this decade.

Last year, U.S WTI averaged $43 but traded in a $28 range, reflecting high levels of volatility. For 2017, the range might not be as wide, but sharp fluctuations will persist.

Last year, U.S WTI averaged $43 but traded in a $28 range, reflecting high levels of volatility. For 2017, the range might not be as wide, but sharp fluctuations will persist. Conflicting signals about the overall direction of oil and OPEC’s attempt to manipulate fundamentals and prices provide an uncertain backdrop for the market. The cartel has certainly put a floor under the market, but it’s not yet clear how high members can push prices. Oil may simply trade in a range of $45-$60, with shale capping prices on the upside and OPEC limiting the downside. Even so, given the various factors impacting the market and the ambiguous signs traders and analysts are now contending with, there are many possible scenarios, with wild price swings, like those seen on Tuesday, commonplace.

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