Sunday, July 21, 2024

Has Oil Risen Too Far Too Fast?

Oil Pump At Sunset

Crude oil has been on a remarkable run since bottoming out earlier this year. After crashing into the mid-$20s to start the year, crude has rocketed higher passing $50 a barrel this week despite the fact that OPEC hasn't done a thing to help the oil market. Instead, what has fueled crude's surge is a combination of temporary supply outages and the growing belief that supply and demand will move back into balance by the end of the year due to the anticipation for steep global production declines. That said, if those catalysts don't hold it's quite possible that crude could give up some of its recent gains.

Supply disruptions mount

One of the big weights on the price of crude over the past year was the fact that there was an abundance of oil supply on the market thanks in part to limited supply disruptions. That has changed this year after growing political unrest in places like Libya, Venezuela, and Nigeria caused output in those countries to come offline. Nigeria's oil industry, in particular, has been hard hit after militants blew up a number of oil wells and pipelines.

In fact, just this week militants blew up another Chevron (NYSE:CVX) oil well in the country. It was the fourth attack in as many weeks on a facility operated by Chevron, which has also had to halt operations at a 160,000 barrel a day export facility. Because of these militant attacks nearly half of Nigeria's 2.4 million barrels per day of production is currently off-line, with militants threatening to cut Nigeria's oil output down to zero.

On top of these geopolitical supply disruptions, wildfires in Canada knocked out a third of that country's oil production at the peak, or well over 1 million barrels per day. Some of those facilities are just starting to come back online, with ConocoPhillips (NYSE:COP), for example, recently restarting one of its key facilities in the region. However, it could be another month before ConocoPhillips and its peers are back to their pre-fire production levels. Further, the fires are not completely extinguished and have recently threatened additional facilities in the country causing several producers to shut down production.

These supply disruptions have clearly had an impact on the price of oil this year. However, as Canada's oil industry gets back up to its prior peak it will add more supplies to a still oversupplied market. Likewise, if the attacks in Nigeria cease that country could start resuming some of its lost output. In other words, these supply disruptions aren't likely to be permanent.

An uncertain forecast

The other big fuel driving oil prices higher this year is the belief that global oil production will decline due to a significant underinvestment in new supplies, with U.S. production expected to see the deepest drop. In fact, in the International Energy Agency's latest oil market report it has revised its forecast for the fall of non-OPEC production. It now sees this output declining by 800,000 barrels per day from last year's average, which is 100,000 barrels per day steeper than its prior forecast.

Having said that, oil production from several U.S. producers has come in well above their own expectations, which is leading many to increase their production guidance for the balance of the year. Production at Pioneer Natural Resources (NYSE:PXD), for example, averaged 222,000 barrels of oil equivalent per day, or BOE/d, during the first quarter, which was well above its guidance range of 211,000 to 216,000 BOE/d for the quarter. Because of this Pioneer Natural Resources increased its production growth outlook for 2016, with it now expecting to grow its output by 12%, up from its prior view of 10% growth. Not only that, but with oil over $50 a barrel the company is seriously considering adding additional rigs, which could boost its output even more by the end of the year. Further, Pioneer Natural Resources was far from the only producer to increase its full-year production guidance, which suggests that oil production might not decline as much as the IEA and other analysts expect.

Investor takeaway

While the price of crude oil has surged in recent weeks, downside risks still remain. Not only was its recent rally ignited by what could just be temporary supply outages, but full year decline projections might not come to fruition due to stronger-than-anticipated production from shale. In other words, there is still the risk that oil might not be done going down, which is why investors could be better off steering clear of riskier oil stocks for the time being.

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Author: Red

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