Forex Trading Library

Can Oil Go Higher?

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Following the OPEC+ meeting last week, WTI crude prices increased substantially, marking further consecutive multi-year highs. Over the weekend, some analysts wondered if crude would reach the $100/barrel mark, an important psychological barrier.

Since then, prices have moderated throughout the start of the quarter. There has been more risk appetite and less interest in commodities.

Nonetheless, the question still remains whether this latest move is just a pullback before the next push towards triple-digit oil, or did last Friday mark the peak?

There’s no time like the present

The thing is, there are three almost inter-competing projections when it comes to where oil will be.

The short-term situation is very different from the medium term expectations. And that is very different from where policymakers want us to be in the long term. But, because oil exploration and production is such capital intensive, and can take years to generate a return on investment, the long-term situation inevitably affects the reaction to the current situation.

A recent paper by JPMorgan showed that crude oil prices are well above where the profitability ratio for shale production in the US is at. Basically, it costs, on average, about $60/bbl to produce shale oil, the largest reserves in the US. At >$90/bbl, that’s quite profitable for shale producers.

So, why aren’t they ramping up production?

The future is now

The question is how long will these prices stay?

It costs money and takes time to ramp up shale production, and by then oil prices might not be as profitable. Particularly if there is a new covid variant that forces prices down. Or if OPEC+ decides to increase supply. Or if regulators once again start putting controls on fracking. All of that makes a quick move to increase supply a risky proposition.

Increased supply is the general control mechanism for increased prices.

The Biden Administration has increased calls for production hikes to deal with the supply and demand mismatch. Crude inventories are well below their pre-pandemic levels, and commercial activity is normalizing.

But, at the same time, governments all over the world are pushing to decarbonize, meaning that demand will fall in the future, along with prices.

The barriers to uncertainty

OPEC plans to gradually increase supply until the market normalizes. In turn, this would imply lower prices, something around the $60/bbl in the medium term.

However, they also estimate that the current price hike is due to switching demand from high natural gas prices. That is primarily due to geostrategic reasons, which could resolve soon. If there’s no resolution, the price of crude will push higher.

In other words, even though the trajectory for oil prices could remain towards pre-covid price stabilization, that doesn’t mean in the short term there won’t be a price spike above $100. Particularly if there is cause to worry about a short-term supply shock, due to geopolitical reasons.

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