Oil prices rallied in 2017, with WTI finishing the year more than 12% higher as major OPEC and non-OPEC producers continued their efforts to rebalance the oil market by curbing their supply. Can this pattern persist in 2018, or will US shale producers ramp up their production in the face of higher prices, and take the wind out of the precious liquid’s sails?
The oil market came close to rebalancing itself in 2017, as a strengthening global economy fueled demand, and the extension of the OPEC and non-OPEC agreement limited supply. Of course, the frequent supply disruptions in the Middle East and Latin America, as well as the dollar’s plunge during the year, also played their role. The start of 2018 saw oil’s uptrend gain even more speed, with WTI surging 5% in just a few days as US crude inventories fell sharply.
Despite the heightened optimism surrounding the energy market, it may be too early to call for a new era of higher oil prices. Yes, both WTI and Brent crude currently rest at highs last seen in 2014 and 2015 respectively. However, the question is whether there is further upside from current levels, or whether a correction lower is due.
Arguing for higher prices, are some recent comments from the United Arab Emirates energy minister, who noted that the OPEC-led supply curbs could be extended beyond their current end-date of December 2018. A continuation of this deal could be a positive development for oil prices in an environment where global demand is growing. Moreover, any future supply disruptions may also provide short-term support for prices. In this respect, Iran, Iraq, Libya, Nigeria, and Venezuela will probably be the key countries to watch.
Arguing for a correction is the fact that the decline in US inventories may prove to be temporary. Some of the drawdowns may be owed to the extremely cold weather observed in the US lately – something likely to abate soon. More importantly, how will US shale oil producers respond to the recent surge in prices? Theory – and the latest forecasts from the US Energy Information Administration – suggest that US producers are likely to boost their output notably as prices rise and their profit margins recover. A massive increase in production would likely cap any further gains in the precious liquid, or even trigger a downward correction. Lastly, the recent civil unrest in Iran may have helped push prices higher on speculation that some Iranian output could go offline. Once, and if, the situation stabilizes, that supply risk may be priced out of oil.
Overall, downside risks seem to outweigh upside risks for oil prices. WTI could finish 2018 somewhat lower, perhaps near the psychological $60/barrel zone. A clear break below that zone could set the stage for bigger declines towards the $55.50 area, though a drop of such magnitude may require a major catalyst, such as US shale oil making a strong comeback. On the flipside, should upside risks materialize, for example in case of consistent supply disruptions, WTI could end the year higher, near $70/barrel. However, any sustained advance from that level could make it even more likely that US production increases, thereby capping any future gains.
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