Oil Approaches $50

What is driving the rise in oil prices and can it sustain?

From the lows of $27/bbl in February 2016, Brent Crude has rallied over 75% as it gets closer to the $48/bbl mark. What has changed in the last 3 months to justify a 75% appreciation in the price of crude oil? Even as Saudi Arabia, Russia and Iran continue to pump oil at record levels, there are supply disruptions at other oil centers.

Turmoil in Nigeria and Venezuela…

 Venezuela was pushed into an economic crisis by cheap oil. Despite its protests within the OPEC, Venezuela could not convince the GCC members of OPEC to agree to supply cuts. The result is that the Venezuelan economy is on the brink and that has also triggered protests on the streets of Venezuela as well as a full-fledged political crisis. With funds drying up, the state owned oil company (PDVSA), is hard pressed to maintain oil output at its normal levels.

Turmoil in the Niger Delta of Nigeria has been another reason for the contraction in global supply of oil. The political turmoil in Nigeria has restricted oil supply to the extent of nearly 500,000 barrels per day. With Venezuela contracting supply by 200,000 bpd, these two nations have contributed to a sharp contraction in global oil supply.

Shale and Wildfires in Canada…

Compared to Venezuela and Nigeria, the United States and Canada are much larger producers and between them account for close to 17 million bpd. In the case of the US there have been a record number of shale oil bankruptcies. Most shale drillers were anyways facing negative cash flows. With the Fed threatening to raise rates and junk bonds out of favor, shale companies have lost their principal source of financing. This has resulted in falling output even as the US remains the largest producer of oil. Canada has seen output being hit by raging wildfires near the mineral sands region that has impacted output. Between Nigeria, Venezuela, the US and Canada, the daily disruption in supply is to the tune of 2.5 million barrels per day. This has virtually wiped out the daily oversupply over the last 2 years leading to incremental supply-demand parity. This has kept prices of oil buoyant.

Road ahead for crude oil prices…

It may be ambitious for the markets to expect a further rise in oil prices. As oil crosses $50/bbl, a lot of unviable shale supply may come back into the market. The Canadian wildfires are expected to have limited medium term impact on oil production. This will ensure that the daily supply disruption falls from 2.5 million bpd to just about 0.5 million bpd during the current year. Oil may perhaps not get back to the lows of Feb 2016 but crossing $50 will still be a tall ask. A sharp rally in crude oil prices may be quite some time away! ©

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