The most likely case is that WTI will remain stuck in the upper $40 to lower $50 range through December 2017.
Comparative inventories have fallen dramatically since mid-February yet oil prices languish in the mid-to-upper $40 range. But what will it take for oil prices to break out of the $45 to $55 range?
WTI prices increased from below $45 to almost $55 per barrel based on expectation that OPEC cuts would quickly balance international oil markets and result in near-term higher oil prices. While that expectation lasted, prices remained near $55 from late November 2016 until early March 2017
Prices adjusted downward four times between March and August as it became clear that output cuts were not enough to produce a meaningful price recovery. Since mid-August, markets have rallied back to the ~$49 per barrel price average since November.
Rising rig counts in U.S. tight oil plays have been the most important factor constraining oil prices. Investors fear that resulting increased output will prevent the market from reaching balance.
Rig counts in the Permian basin, Bakken and Eagle Ford plays began increasing after WTI fell below $30 per barrel in early 2016. Since OPEC first suggested the possibility for a production cut in August 2016, tight oil rig counts have more than doubled
While the increase in the number rigs is impressive, the most revealing aspect is the decline of the Eagle Ford, and the flattening of Permian basin and Bakken rig counts since June. This suggests that the appetite for tight oil plays among equity investors may be moderating.
Despite claims of sub-$40 per barrel break-even prices by Permian basin producers, rig count data indicates that overall play economics require higher prices. The weekly change in Permian rig count suggests that break-even WTI prices may be closer to $55 or $60 per barrel. Break-even prices for some producers are certainly lower but higher prices are required for the average company.
Above all, rig count reflects capital flows and the availability of other peoples’ money to fund the tight oil plays—this is critical to production maintenance and growth. Capital availability is dependent on expectation of $55 to $60 oil prices. Capital flows have apparently faded with those expectations or else producers are using available capital for other purposes in addition to drilling.
Comparative inventory (C.I.) fell 117 million barrels (mmb) from mid-February through the end of August. This is the most significant oil market development since oil prices collapsed in 2014 but it has had little impact on oil prices so far.
Lower net imports of petroleum products is the main reason for this reduction in C.I. Refinery intakes are at record levels as refiners produce and sell refined products in the U.S. and abroad. As I pointed out last month, this trend is only sustainable if demand for U.S. refined products persists.
While exporting products helps reduce U.S. stocks, it aggravates the global over-supply of liquids. Higher net imports in recent months suggest that this trend may be weakening or ending.
I estimated a range of probable year-end C.I. values to be between 55 and 75 mmb using EIA August STEO inventory forecasts and 2017 inventory decline trends. This range of C.I. translates to December WTI prices between $48 and $51 per barrel.
Large reductions in C.I. so far have not resulted in meaningful increases in oil prices because the yield curve is fairly flat. That is typical of outsized storage levels.
Oil prices collapsed in 2014 because of excess supply from over-production. Low prices and the contango term structure of forward curves encouraged putting large volumes of crude oil and refined products into storage.
By Art Berman for Oilprice.com
