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Why oil is headed to $70 a barrel

Last week, the price of a barrel of West Texas Intermediate crude oil exceeded $50 for the first time since July. In six to 12 months, we believe higher prices should be here to stay.

The market is oversupplied, and oil may experience relapses on a short-term view. Nevertheless, it is reasonable to suppose that, a year from now, when we expect the oil market to be balanced, the Brent crude price may trade at $72 and WTI at $67.


Last week's price rise, totaling roughly 10 percent, was initiated by the large drop in U.S. oil rigs in early October. U.S. oil-directed rigs fell to a five-year low of 614 a few weeks ago, according to Baker Hughes, and then to 605 on Friday.

Further, the U.S. Energy Information Administration estimates that U.S. crude production dropped by 120,000 barrels per day to a 12-month low of 9.01 million barrels per day in September from August. The EIA also raised its oil-demand growth forecasts for 2015 and 2016, while cutting 2015 non-OPEC supply growth. U.S. oil demand continued to expand at a solid pace, up 3.5 percent year-on-year to 19.98 million barrels per day in July.

Finally, senior executives made a number of upbeat comments about the oil price at an industry conference in London. Among others, Fatih Birol, executive director of the International Energy Agency, described this year's oil-investment cuts as the biggest in the history of the sector, with spending on upstream projects down at least 20 percent.


Geopolitical developments have also contributed, with market participants rebuilding an oil-price risk premium attached to potential production outages in the Middle East. Fighting in Syria (and Russia's intervention there), plus attacks by ISIS on production facilities in northern Iraq — all of this has raised the risk of outages occurring.

Of course, oil nations and businesses could be forgiven for being skeptical of the latest price rally, which is on track to be the longest since April. Several promising rallies in crude have fizzled out over the course of 2015. In January, Brent climbed over 30 percent, raising expectations that the worst was over for oil producers. A second rally between March and April met with the same fate. However, we think the latest one is based on firmer foundations.

In emerging Asia, where economic concerns have risen, oil demand has been resilient. In China and India, it rose by around 7 percent in August from a year earlier. Regionally, oil demand is primarily supported by gasoline consumption. As a whole, supported by low oil prices, we expect global oil demand to climb by 1.7 million barrels per day this year, its fastest pace in five years. While market concerns of a Chinese hard landing have increased of late, we assign a low probability to such an event. Additionally, solid demand through August suggests it is too early to say if the oil rebalancing process has been delayed materially.



Further, the ongoing steep drop in the oil-rig counts around the globe, together with project deferrals and cancellations, will, in our view provide the base for non-OPEC oil production to contract by 0.2 million barrels per day in 2016.

It is important to bear in mind that there is still an oversupply of oil. The market remains in surplus to the tune of 1 million barrels per day in our view, which should cap any upside to price rallies on a three-month basis. Nevertheless, rebalancing forces on the demand and supply sides should support higher prices on a six to 12-month basis.

In terms of market balance, we think the oil market could be cleared in the second half of 2016. We see Brent crude oil at $72 a barrel within 12 months.

Commentary by Giovanni Staunovo, a commodities analyst at UBS Wealth Management, which oversees $1 trillion in invested assets. Follow UBS on Twitter @UBS.