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ANALYSIS: Crude oil prices may finally be finished their epic crash, or the recent rally could simply be the calm before an even more dramatic storm. Below, BNN looks at what factors are justifying hopes of even higher prices from here as well as what could send the rally into rapid reverse.
OPEC RETURNS TO RELEVANCE = PRICE POSITIVE
The agreement struck between Russia and Saudi Arabia earlier this week to cap production, albeit at record levels, is significant. Canadian energy executives believe the deal will, at the very least, send a psychological signal to the market that prices have hit bottom. There is no shortage of caveats to this, particularly given both countries’ history of reneging on such agreements and Iran steadfastly refusing to stem its own production to pre-sanctions levels, which would add more than one million barrels to an already oversupplied market. Nonetheless, after more than a year of failures to find consensus within the world’s erstwhile oil cartel and its closest contemporaries, any agreement is a significant step towards price stability.
STOCKPILES STOP SURGING = PRICE POSITIVE
Arguments suggesting oil prices have yet to hit bottom are, at least partly, based on the dramatic growth in petroleum inventories around the world. As storage reaches capacity, goes the theory, and producers are forced to rent tankers to keep their excess oil floating nearby, costs go up and prices collapse further as the supply glut reaches even more extreme levels. Trouble is, the data does not support this theory.
Michael Tran, commodity strategist at RBC Capital Markets, notes in a report published Thursday morning that storage capacity in the United States appears to be close to 91 percent. After stripping away crude still in transit, lease and pipes stocks, however, Tran concludes “true” U.S. storage levels are actually closer to a “more palatable” 73 percent.
RIG COUNT COLLAPSE FINALLY CRUSHES OUTPUT = PRICE POSITIVE
During the early days of the price crash, in late 2014, the total number of rigs drilling for crude oil across North America started to dramatically decline as future profit expectations waned. The subsequent sinking of production did not come anywhere near as quickly as many expected. Producers managed to squeeze more efficiency out of the rigs still in operation; but once those wells run dry and few if any are drilled to replace them, output simply has to fall. In a report published last month, CIBC found the rig count in the United States was more than 40 percent below the level needed to maintain even flat production.
SLOWER ECONOMIC GROWTH = PRICE NEGATIVE
The only way to permanently end the global crude oil price rout, if not from a broad-ranging cut to output, is for increasing demand to sop up the oversupply. That looks increasingly less likely to happen in light of the latest report from the Organization for Economic Co-operation and Development, which on Thursday cut global economic growth expectations for this year and called for “urgent” global policy action. Those who are continuing to look eastward to China for growth of sufficient magnitude to offset the sluggish pace of the rest of the world will be disappointed. The world’s second-largest economy is still expanding, of course, but Chinese growth is at its slowest pace in a generation and the deceleration means this will almost certainly not be a demand-based recovery.
BARRELS FROM BANKRUPTCY = PRICE NEGATIVE
Put any three chief executives of publicly-traded crude oil producers anywhere in the world together in the same room, and the latest Deloitte report says one of their firms will be bankrupt by the end of this year. The global consulting giant said earlier this week there are 175 public oil companies around the planet carrying a collective US$150-billion in debt, pushing them towards what Deloitte describes as a “high risk” of bankruptcy. Oil bulls may look at a figure like that and think huge drops in supply are soon at hand as all those companies enter creditor protection and turn off their taps, but they would be mistaken. Creditors want all the cash they can get from bankrupt companies and in the case of oil producers, debtholders usually force them to extract all the barrels they can in order to pay back as many of their loans as possible. The same Deloitte report found 80 percent of U.S. oil companies that have declared bankruptcy since July 2014 are still producing today.
REFINING MARGIN REVENGE = PRICE NEGATIVE
Anyone who has balked at gasoline pump prices falling nowhere near as much as the price of crude oil understands the profit potential of the refining business. Many crude oil producers with so-called “integrated” business models – those who both produce and refine crude oil – have been able to insulate themselves from the losses on the production side by making up the difference with higher margins on the refining side. That safety net has all but disappeared.
As recently as November of 2015, refiners in the U.S. Gulf Coast region were able to make roughly US$9.80 in profit from every barrel of crude oil they turned into other petroleum products such as gasoline, heating oil and jet fuel. Barely three months later, at the start of February 2016, that margin had fallen by more than half to roughly US$4.50 per barrel. That means refiners, especially the independent ones without their own production businesses.