OIL Price Correction Coming?

While UK Brent oil when up +0,78%, the DXY (Us dollar index) went down -0,57% for last Friday Feb. 5th.

Even as Baker Hughes reported a rise in the number of active drilling rigs in the United States on Friday, oil prices continued to see gains on Friday afternoon.

Friday afternoon, Brent was still up over 1% on the day, at $59.44—dangerously close to the $60 psychological threshold for the benchmark.

Last week at this time, the spot price for Brent was just $55.04. The near $5 gain is due to a combination of factors, including a large crude oil inventory decreased in the United States, continuing OPEC+ production restraint, Aramco’s price hike to crude for Europe, U.S. traders high on stimulus chatter, and whispers of an overall tightening oil market.

These are bullish signals indeed. But can this uptrend last amid lockdown extensions and oil demand that just isn’t there yet?

When a stimulus deal is finalized, oil prices are expected to jump—this is certainly still bullish. But on the bearish side, oil demand is still lagging, and some analysts are not calling for a full rebound in demand for years—if ever. 

The EIA, for one, doesn’t see U.S. energy consumption rebounding fully for another eight years. That’s certainly on the bearish side.

Will OPEC will be able to hold back the flood of supply until that time? Can they afford not to? Russia is still itching to ramp up its oil production, leery of opening the door for U.S. shale producers. For now, Saudi Arabia is happy to take one for the team, resigned to curb production so others in the group will continue with at least some of the cuts.  For now, OPEC’s actions are bullish.

The EIA sees U.S. oil production setting new records, but not until 2023.

Goldman Sachs, however, is still bullish, calling for $65 Brent by mid-year, with WTI in the low $60s.

Rystad Energy, however, sees a price correction on the horizon. 

“Many technical indicators are flashing red, so a price correction soon would not be unsurprising,” Rystad said on Friday, according to Oilfield Technology.

The Four Factors That Drive Up Oil Prices

High oil prices are caused by high demand, low supply, OPEC quotas, or a drop in the dollar’s value.

High Demand 

Demand for oil and gas typically follow a predictable seasonal swing. Demand rises in the spring and summer due to increased driving for summer vacations. Demand drops in the autumn and winter. Even though heating oil use rises in the winter, it’s not enough to offset the post-vacation drop in gasoline demand. 

Commodities futures traders anticipate increased demand. They usually start bidding oil prices higher in January or February. Around 50% of gas prices are based on oil prices.1

Low Supply 

Low supply occurs when war or natural disasters curtail exports from oil-producing countries. Traders often bid up prices when they hear of impending disasters or the threat of war. Oil prices decline once production resumes.

OPEC Quotas 

The third factor is when OPEC members reduce their output. That’s what caused high oil prices in 2017 and 2018. On November 30, 2016, the organization first agreed to cut production by 1.2 million barrels per day starting January 2017.2 It agreed to extend production cuts through 2018.3

OPEC has been battling U.S. shale oil producers for market share. Shale producers pushed U.S. oil production to 9.4 million barrels per day in 2015.4 That knocked OPEC market share to 41.8% in 2014 from 44.5% in 2012.5 The supply bump caused oil prices to fall. That created a boom and bust in the U.S. shale oil industry.

OPEC doesn’t want prices to be too high or for alternative fuel sources to start to look good again. OPEC members are generally looking for a target price for oil of $70-$80 a barrel. But U.S. shale producers need $40-$50 a barrel to pay the high-yield bonds they used for financing.6 Until 2016, OPEC accepted the lower price to maintain market share.

Dollar Decline 

The fourth factor that determines oil prices is a dollar decline. 

Most oil contracts around the world are traded in dollars. As a result, when the dollar declines, it costs more to buy a barrel of oil. Conversely, when the value of the dollar rises, it costs less to buy a barrel of oil. 

Historically, this inverse relationship has been fairly strong. However, in recent years, the correlation has weakened, largely due to the evolving global energy industry and the United States’ increasingly strong oil-exporting capabilities.

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