What Will Be The Price Of Oil At Year’s End? Survey Results Are In.

Without a doubt, the crash in the price of oil was last year’s biggest market surprise. Nobody predicted prices would drop so fast – from $105 all the way to $45 a barrel.

Now that prices seem to have stabilized, the questions are: Will oil recover back up to $100 or more? Or will it plunge to even lower levels?

Today, I’d like to go over the results of our February survey, when we asked fellow readers of the Daily Pfennig® newsletter for their year-end oil price expectations. And, thanks again to everyone who voted.

Half of the participants thought oil would remain trapped in a range between $50 and $74.99. As you’ll see in today’s article that sounds like a very reasonable opinion. There are a few factors that could help oil remain trapped in a range, instead of falling to new lows or rising back above $100 a barrel. Let’s take a closer look at those factors.
What’s Behind Oil’s Recent Rebound?
You may have noticed the price of oil has been increasing lately. The main reason for this rebound can be found in this popular commodities axiom: “The cure for low prices is low(er) prices.” It refers to the fact that producers of commodities tend to cut supply when prices drop below cost. And, that’s exactly what’s going on in the energy sector.

The plunge in oil prices has already forced many oil companies to implement aggressive production cutbacks. Half the country’s drilling rigs have come offline. As a result, the U.S. Energy Information Administration (EIA) predicts that the U.S. will have its first net drop in oil production since 2008 this month.1

According to the EIA, output from North Dakota’s Bakken, one of the major U.S. shale regions, will decline 23,000 barrels a day to 1.3 million in May. And, output from the Eagle Ford in Texas, the second-largest oil field in the U.S., is expected to fall 33,000 barrels a day to 1.69 million.2

With this expected slowdown in production, in addition to other factors such as other countries slowing down production, the price of oil has jumped about 16% since mid-March, as you can see in the chart below. However, this short-term recovery may not last too long. There are a couple of factors that may limit oil’s upside potential.

Source: EverBank Research Team, based on analysis of data released by the U.S. Energy Information Administration.

Why It’s Unlikely Oil Will Move Back Above $100
The great majority of our poll’s participants, about 95%, think it’s unlikely oil will end the year above $100 a barrel. There are good reasons to believe our readers are right. Absent a crisis in the Middle East, I think that it’s unlikely oil will trade above $100 in the short-term. The main factor that may prevent oil from moving much higher is something called “fracklog.” It refers to the backlog of drilled wells that U.S. drillers plan to hydraulically fracture and place into service as soon as prices rebound.

The number of wells waiting to be hydraulically fractured has tripled in the past year, as drillers wait for prices to recover. According to analysis from Bloomberg, there are 4,731 wells from Texas to Pennsylvania on hold.3 That means drillers are keeping 322,000 barrels a day underground. That’s additional supply that may be released into the market once the price of oil increases to economic levels of production, probably around $60-65 a barrel.

The higher the price of oil, the more incentive large independent producers such as ConocoPhillips, Occidental Petroleum Corp., and EOG Resources will have to start eating into their backlog. As recently stated by ConocoPhillips CEO Ryan Lance, “Those who are drilling and deferring completions – obviously, if they get a price signal that the commodity price is coming back a little bit, you’ll see more supply come on. If $80-$90 [per barrel] comes back, there’s a good chance that $50-$60 comes back as well because of all the new oil that will come online from completed wells.”4

We could also see additional supply coming from international markets. The Organization of Petroleum Exporting Countries (OPEC) continues to increase production as a way to defend their market share in Asia and Europe. For example, Saudi Arabia, the world’s biggest oil exporter, added 658,800 barrels per day in March to bring its production to 10.3 million barrels per day, its highest level in three decades.5

OPEC will meet again on June 5 to discuss its strategy. But, I think that it’s unlikely they will cut production by a significant amount. Remember, the collapse in oil prices started after the Saudis decided to keep up output as a way to compete with U.S. shale producers. And, Saudi Oil Minister Ali Al-Naimi recently said that his country wouldn’t cede market share to higher-cost producers. So, it seems more likely Saudi Arabia will continue to follow this strategy and will not cut production.6

The bottom line is oil’s downside may be limited by recent production cuts. At the same time, the fracklog, along with the Saudis’ new strategy, will act to cap the price of oil. As a result, oil is likely to remain trapped in a trading range for the rest of the year. But, that’s not necessarily the end of the story.

As long-time readers of the Daily Pfennig® newsletter know, we refer to oil as an anti-dollar asset, meaning we must always be conscious of an inverse correlation between dollar performance and oil prices. For instance, since a high of 99.99 on April 15, 2015, the Dollar Index fell 5.2%7 through the end of April, but oil has risen almost 10%.8 So, it’s entirely possible that we could begin to see oil prices creep up, especially if we’re on the verge of a currency turnaround and weakening dollar, which Chuck hinted at last week.

Until the next Daily Pfennig® edition…

Mike Meyer
Vice President
EverBank World Markets, a division of EverBank