Oil Producers Are Curbing Supplies. Expect The Oil Rally To Continue
2 min
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Increased global demand, together with recent supply cuts, could spark a more than 20% rally in oil prices this year, experts say.
“We expect prices to peak at $65 and remain in the range $55 to $65,” says Art Hogan, chief market strategist at National Securities Corp. in New York.Futures contracts for light sweet crude were recently fetching $53 a barrel on the Commodities Mercantile Exchange.
Traders wanting to profit from the potential rally should consider buying June-dated futures contracts for light sweet crude on the CME. Alternatively, they could try purchasing the Invesco DB Oil exchange-traded fund (ticker: DBO), which holds a basket of crude oil futures. The fund has gained 7.5% this year through Jan. 11. It lost 21% in 2020, according to Morningstar.
This year crude has already rallied about 9%, due in part to an unexpectedly bullish move by OPEC+ (the Organization of the Petroleum Exporting Countries plus Russia) earlier this month.
The world’s second-largest producer, Saudi Arabia, surprised the world by announcing it would cut production in February and March by one million barrels a day (bpd). That move more than offset a combined 75,000 bpd increase for the same period by Russia and Kazakhstan.
Overall, the OPEC+ cut should help put a floor under prices, especially given that the member states will probably stick to their quotas. “We don’t see material risk to the group’s [OPEC’s] cohesion,” Barclays said in a recent report. Historically, OPEC members have often failed to stick to their production quotas, making price stability an issue.
Meanwhile, demand from China is higher than pre-pandemic levels. In the third and fourth quarters of 2020, the country consumed 13.7 million and 14 million bpd, respectively. That compares to an average of 13.3 million in 2019, according to OPEC.
Traders will likely bet on a rebound in demand for the rest of the world as Covid-19 vaccines allow people to return to business as usual. “My sense is that as we get back to a more normal society, we get a massive surge in people wanting to go flying and do things they could do before the pandemic,” says Jon Rigby, an oil analyst at UBS London. Such a scenario would mean an increase in oil demand, with air and land travel resulting in higher fuel consumption.
Oil prices will get an additional boost from a softer dollar. “My general view is that we won’t have a stronger dollar,” says Steve Hanke, professor of applied economics at Johns Hopkins University. “Automatically, a little bit weaker dollar will add a little bit of strength to the oil price.” Oil gets priced in dollars, which means that in general, when the dollar weakens, crude prices tend to rally.
A price rally will likely be tempered by increasing supply from shale producers in North America, says Hogan of National Securities. While the Biden administration will likely reduce drilling on federal lands, there is still a lot of potential supply ready to tap when crude prices approach $60. “There is plenty for us in the next two years to increase our supply with hydraulic fracking,” he says.
Buying any commodity futures contract is a risky endeavour, and oil futures are no exception. The price of crude is subject to influences by national governments, geopolitical upheaval, and changes in the global economy. All these can result in significant price volatility.
Despite that, the odds looked stacked in favour of a rally in crude prices over the next few months. “We see prices going higher, if not meaningfully higher,” says Daryl Jones, director of research at Hedgeye Risk Management.
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Mortgage holders should brace themselves for more pain as the Reserve Bank of Australia board prepares to meet tomorrow for the first time this year.
Most economists and the major banks are predicting a rise of 25 basis points will be announced, although the Commonwealth Bank suggests that the RBA may take the unusual step of a 40 basis point rise to bring the interest rate up to a more conventional 3.5 percent. This would allow the RBA to step back from further rate rises for the next few months as it assesses the impact of tightening monetary policy on the economy.
The decision by the RBA board to make consecutive rate rises since April last year is an attempt to wrestle inflation down to a more manageable 3 or 4 percent. The Australian Bureau of Statistics reports that the inflation rate rose to 7.8 percent over the December quarter, the highest it has been since 1990, reflected in higher prices for food, fuel and construction.
Higher interest rates have coincided with falling home values, which Ray White chief economist Nerida Conisbee says are down 6.1 percent in capital cities since peaking in March 2022. The pain has been greatest in Sydney, where prices have dropped 10.8 percent since February last year. Melbourne and Canberra recorded similar, albeit smaller falls, while capitals like Adelaide, which saw property prices fall 1.8 percent, are less affected.
Although prices may continue to decline, Ms Conisbee (below) said there are signs the pace is slowing and that inflation has peaked.
“December inflation came in at 7.8 per cent with construction, travel and electricity costs being the biggest drivers. It is likely that we are now at peak,” Ms Conisbee said.
“Many of the drivers of high prices are starting to be resolved. Shipping costs are now down almost 90 per cent from their October 2021 peak (as measured by the Baltic Dry Index), while crude oil prices have almost halved from March 2022. China is back open and international migration has started up again.
“Even construction costs look like they are close to plateau. Importantly, US inflation has pulled back from its peak of 9.1 per cent in June to 6.5 per cent in December, with many of the drivers of inflation in this country similar to Australia.”
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