Futures markets indicate that bullishness on the price of oil is reaching 12-month highs, a surprising development when most signs point to minimal upside for the commodity's price.
The first chart below compares the West Texas intermediate crude price with speculative futures positioning (the Commodities Futures Trading Commission releases the data weekly and the "Non-Commercial" category is used as a proxy for hedge fund investments).
The relationship between the two data sets is largely coincident – they move in the same direction at the same time. Since mid-September, however, the net futures positioning has climbed significantly and is now close to levels last seen in July, 2014, before oil began its massive swoon.
The potential for an OPEC agreement limiting production is the main driver of optimism in the sector but spot crude prices, while higher, are not reflecting the same bullishness.
The fundamentals underlying oil prices remain weak. For all the production cut talk, the Financial Times noted Tuesday that the cartel's production hit a record 33.6 million barrels a day in September. Global oil inventories remain near record levels above three billion barrels and in the U.S., the important market for Canadian producers, inventories are more than 8 per cent above the record highs set in 2015.
The good news for investors in the oil sector is that global demand is expected to increase by 1.2 million barrels a day in 2017 according to the International Energy Agency (IEA), and global supply and demand could be in balance – as opposed to the current oversupply situation – in the latter half of the year.
The IEA also believes, however, that any commodity price rally on balanced markets will be short-lived. Fatih Birol, the organization's executive director, noted his expectation that when oil approached $60 (U.S.) a barrel, U.S. shale production would again begin to grow, potentially tipping markets back into oversupply.
The second chart below shows that U.S. production may already be poised to rise. The Baker Hughes United States Crude Oil Rotary Rig Count has moved in the same direction as the oil price, only with a multiweek lag. The number of operating oil rigs has already increased from a low of 316 in late May to 428 rigs currently. The previous trend of the number of rigs lagging the oil price suggests that more will come on line in the U.S. in the coming weeks.
These factors combine to suggest a range-bound market for oil and oil stocks for the foreseeable future. Rising global demand, particularly from India and China, should keep the price of crude from significant declines. But excess in the form of idle shale oil wells is likely to prevent sustainable rallies much above $60 per barrel.
Scott Barlow