Why Oil Will Not Rally Further

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Includes: BNO, DBO, DIG, DNO, DTO, DWTI, OIL, OLEM, OLO, SCO, SZO, UCO, USL, USO, UWTI
by: Jonathan Weber

Summary

Oil prices grew substantially over the past weeks.

Oil is unlikely to rally further.

The supply surplus is not solved at all; slightly lower US production is offset by higher production from OPEC, Russia and the oil majors.

Oil prices (NYSEARCA:OIL) have increased substantially from the February lows in the 20s, but I believe further substantial oil price increases are unlikely for the foreseeable future, due to a number of reasons.

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The first point that will prevent oil prices from rising much is the current supply and demand situation: Supply outstripped demand for the past quarters, which was the reason for the huge oil price decline in the first place. Despite a lot of analysts claiming that the supply-demand imbalance would dissolve in a short time, there is still a substantial surplus in oil production (versus oil consumption).

Data from the EIA (from March 2016) shows that global consumption is still lacking behind global production by a rather wide margin: Q1's daily global production is seen at 95.6 million barrels a day, whereas consumption is seen at 93.7 million barrels a day, which means the supply-demand gap still sits at 1.9 million barrels a day despite oil prices being down for well above a year now.

Even in Q4 of 2017, global oil supply is seen slightly above global oil demand, although the gap is forecasted to have narrowed down to 0.1 million barrels a day. Nevertheless, this means that the EIA believes that oil supply will remain "too high" for the next two years, which will prevent prices from increasing much above the current level.

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US oil production has declined slightly over the past months, after topping at 9.6 million barrels a day last summer. Yet, the 0.6 million production decline we have seen since is not nearly big enough to balance global oil supply and demand, especially since a lot of other producers are not cutting production at all.

As we see in this table, OPEC has increased production drastically over the last year, upping its daily production level from 30.8 million barrels of oil to 32.3 million barrels of oil (or 1.5 million barrels a day, more than twice the reduction in the US from peak levels). This does not even include the future ramp up of Iranian oil production yet, which is likely to affect OPEC's 2016 and 2017 production levels substantially.

Russia has increased its oil production as well; Russian oil production has hit a record high in January (production in the country stood at 10.9 million barrels a day).

The Russia-OPEC freeze thus does not matter a lot since the countries involved basically agreed to freeze production at record highs, which will mean production (from these countries) will not increase further, but will likely not decline either, which means the supply surplus will remain unchanged.

Major oil companies also keep increasing production at a rather high pace, mainly due to large investments in the past years, which results in major projects coming online now:

Company Production in Q4 2015 versus prior year
Exxon Mobil (NYSE:XOM) 4.25 million barrels a day up 4.8 percent
Chevron (NYSE:CVX) 2.67 million barrels a day up 3.5 percent
Shell (NYSE:RDS.A) (NYSE:RDS.B) 3.04 million barrels a day down 5.0 percent
BP (NYSE:BP) 3.40 million barrels a day up 5.9 percent
Total (NYSE:TOT) 2.35 million barrels a day up 5.5 percent
Combined 15.71 million barrels a day up 3.0 percent
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In this table, we see that Exxon Mobil, Chevron, Shell, BP and Total increased their production by a combined 3 percent, or about 0.5 million barrels a day over the last year. In other words, the production increases of these five companies alone are big enough to offset the effect of lower US oil production almost entirely (US production declined 0.6 million barrels from the peak).

We can thus conclude that the supply-demand gap, which is the major reason for the oil price downturn we have seen over the last two years, is not closed at all, and will not be closed for the foreseeable future.

Takeaway

US production has declined slightly from its peak last summer, but this was more than offset by production increases from OPEC countries as well as Russia. Major oil companies also increased their production by half a million barrels a day over the last year.

With the Iran production ramp up not showing up in these numbers and OPEC and Russia not agreeing on any production cuts (just on a freeze at the current record high levels), I believe global supply will continue to outstrip global oil demand, which will mean oil prices will not rise much from the current level until this imbalance narrows down substantially, which could mean a couple of more quarters (or possibly years) of oil prices trading around the current levels.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.