Crude oil prices have rallied between 25% and 33% over the past 30 days, according to Finviz, depending on whether you look at WTI or Brent crude oil. With an OPEC meeting coming up in late March, many traders are reducing their short positions in anticipation of a supply cut designed to send prices higher. The problem is that oversupply remains a big problem and U.S. production may keep a ceiling on prices near their breakeven production costs.
Below, CommodityHQ.com takes a look at where crude oil prices may be headed and whether the current rally is likely to continue or run out of steam.
Traders Pare Down Short Positions
The short-term crude oil rally has been driven in large part by traders covering short positions ahead of the OPEC meeting in late March. According to the CFTC’s Commitment of Traders, traders cut their short positions by 15% during the week ended March 1, which means they repurchased contracts on the open market. These traders are likely hedging their bets ahead of OPEC’s upcoming meeting on March 20 in Moscow.
During the upcoming OPEC meeting, OPEC and non-OPEC countries will discuss the production freeze that was tentatively agreed upon earlier this year. Both Saudi Arabia and Russia will be seated at the table in Moscow to make the decision, which many experts believe will increase the probability of a deal being struck. Depending on the price levels agreed upon, the production freeze could send crude oil prices higher by constricting supply.
The supply of crude oil also continues to fall in the United States. According to the EIA, U.S. crude oil production is projected to decrease from an average of 9.4 million barrels per day in 2015 to 8.7 million barrels per day in 2016 and 8.2 million barrels per day in 2017. Production has already fallen by 600,000 barrels per day since April 2015 to an average of 9.1 million barrels per day in February. Interestingly, the entire decline comes from the Lower 48 onshore with prices remaining below their breakeven.
Major U.S. oil producers have confirmed that these trends are likely to continue. In February, Apache Corporation (APC) announced that it would cut its 2016 budget by half and warned that output would dip by 7% to 11% from its 2015 pro-forma production. This follows Continental Resources’ (CLR) January announcement that its production would be cut by 13% this year. Many other oil companies have made similar cuts amid the low prices.
It’s no wonder that crude oil prices have started to rally given these dynamics, but the primary question on the minds of investors is whether or not the rally has legs.
Price Ceilings & Supply Woes
Crude oil prices may be rallying from lows reached in 2016, but many bearish investors believe that the rally may be short-lived given the commodity’s new economics.
According to the API, U.S. crude oil supplies reached a record 10.4 million barrels as demand has failed to absorb the excess capacity. These inventories are at an 80-year high for this time of year, while Reuter’s polls suggest that the figure could rise by a further 3.9 million barrels. With storage becoming increasingly limited for these supplies, an ongoing oversupply could increase storage costs and ultimately force fire sales of the commodity.
Many conventional wells in the United States have a breakeven point as low as $10 per barrel, but newer hydraulic fracturing plays have much higher breakeven points of between $30 and $70 per barrel. Low crude oil prices may force producers to turn off some of these wells and stop production, as well as potentially reduce investments in future wells. There’s little doubt that this production would return as soon as it’s economically viable.
The current rally also bears an uncanny resemblance to a short-lived rally that occurred back in the second quarter of 2015. After falling sharply from over $100 per barrel, the commodity rebounded from $50 to $70 per barrel. The rally turned out to be short-lived as OPEC acted to increase supply in order to cut out U.S. production. With the current rally, the same could occur if OPEC decides to keep pressure on U.S. producers to discourage future investments.
The Bottom Line
Crude oil prices have rallied between 20% and 30% over the past month, driven by short-term traders looking to hedge their short bets ahead of OPEC’s March 20 meeting. Prices are also being supported by a decrease in crude oil production in the U.S. Despite these short-term bullish indicators, the long-term picture remains a little less clear with an ongoing increase in supply and the resilience of U.S. producers in creating a price ceiling.
In the end, the future of crude oil prices will likely be half decided during the March 20 meeting. Bulls are hoping that this rally doesn’t end the same way as the Q2 2015 rally did.