What’s next for oil prices?

The recent rebound in the price of crude oil — up some 40 per cent from the March low — dragged energy stocks higher through the beginning of the month. This, in turn, has powered a rebound in inflation expectations in the fixed-income market, punishing long-term Treasury bond prices and pushing up yields. Corporate earnings look set to rebound. Just like that, all is right in the world again. Whew.

But doubts are growing about the sustainability of the oil rally given still high inventory levels, high US production, and now, reports that the Saudis are ramping up production in a belief they've “won” the showdown with high-cost American shale drillers. (The data suggest otherwise, with production out of the Bakken shale in North Dakota rising in March for the first time this year.) Barclays believes that without a rapid improvement in the supply vs demand fundamentals, current pricing cannot be sustained.

They list three reasons to be cautious about this happening: China’s economy still looks fragile, oil supply still exceeds consumption and the oil price recovery may encourage more US-based producers to restart drilling operations. Goldman believes that some of the buying that came into oil futures was driven by pair trades playing the relative cheapness of crude against the shares of exploration and production companies. Now, the valuation gap has closed, oil stocks are trading at stretched multiples and oil is trading at a premium to its own still-shaky fundamentals.

Goldman’s analysts are looking for crude price weakness in the near-term. The decline is likely to be magnified by the fact that oil speculators are as net long as they were when oil traded near $100 a barrel. With US production relatively stable, the Goldman team worries about the massive ramp-up in Saudi drilling rig counts. To me, it looks like Riyadh is doubling down on its strategy to force a consolidation of the US shale industry by pushing prices back towards their lows.

To do this, the Saudis need to flood the market when enough cheap oil to top out storage capacities. Ed Yardeni of Yardeni Research posits that it's also possible that global oil demand has bounced back more strongly than expected and that developing countries like China are stockpiling more oil. He also notes that petroleum inventories have been drifting lower (as is normal this time of year) and that railcar loadings (a proxy for US production) have dropped noticeably over the last few weeks.

Still, he admits that the ratio of global oil demand to global oil supply — based on 12-month averages — continued to fall in April for the 14th month in a row to the lowest level since October 1998, a time when crude oil traded down near $15 a barrel and a gallon of regular gasoline cost about $1. While we probably won't see those levels ever again, with the Saudis preparing to open the spigots, energy prices at the very least seem poised to retest the lows set earlier this year. (The Fiscal Times)

By Anthony Mirhaydari