Is oil ready for a rebound?

On September 2, WTI crude oil settled at $46.25 per barrel. On Friday, WTI settled at $46.59. And in between, crude oil settled as low as $43.20 and as high as $49.63. Now what?

While some might see crude oil falling into a manhole to $30 or less, I think market sentiment may be starting to change, and around the corner is a slow ramp upwards to $55 by January 2017. But like the last two months, the path may be more akin to a rollercoaster.

How bad can it get? There is plenty of bearish news out there. Crude oil inventories are rising in the U.S., having reached 480 million barrels last week and I expect more builds as we progress through the spring refinery maintenance season in the first quarter of 2016. I think that crude oil inventories will surpass 500 million barrels and the market simply will not like that headline.

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Later this year OPEC will hold another meeting at which they will decry lower oil prices and probably do nothing about it. Hmmm….But maybe…(See my bullish comments below). Also in early 2016, presuming the International Atomic Energy Agency gives its okay in December, Iranian oil will start returning to the market. The Iranians claim they will increase production 500,000 barrels per day immediately increasing to 1 million barrels per day several months later - more bad news for the oil market to digest. And finally there is Libyan oil production which the market had forgotten about. While peace is not expected to break out anytime soon, Libyan oil production has increased to 430,000 barrels per day and further increases are once again bearish for the market.

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So between now and the end of the first quarter of 2016 looks to be the darkest before the dawn for the oil market and I think the market makes another run at $40 per barrel, perhaps even $37 or $38. But my perception is that there is simply too much buying at the lower levels as the market senses change is coming in 2017 and beyond.

Now, the good news: On shore oil production in the U.S. is declining. The decline in the rig counts is having an effect. While U.S. weekly production estimates from the Energy Information Administration have been declining from about 9.6 million barrels per day in May and June to 9.1 million barrels per day last week, something else happened — U.S. Gulf of Mexico production increased by over 200,000 barrels per day, meaning the effect of the lower rig count on oil production may be more significant than one might think.

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Upstream earnings for big oil were terrible. Exxon upstream earnings were down 79 percent, BP 96 percent, Chevron 99 percent while Anadarko and Conoco Phillips lost $2.2 and $1.8 billion respectively. The producers are cutting costs, cutting investment, cutting jobs. Shell for example cancelled its big Arctic project and its Carmon Creek Canadian Oil sands project. Other high cost areas in deep-water - Gulf of Mexico, the North Sea, West Africa or Brazil - will see projects delayed, deferred or cancelled. This means that investments today will not produce oil 3, 5 or 7 years in the future. While Conoco Phillips and Chevron have stated that they will maintain dividends, they are no longer sacrosanct. Marathon Oil Company cut its dividend 76 percent. Oil prices will have to rise in order to encourage additional production. And U.S. shale producers will then benefit.

Add to the bullish side of the ledger that the market has virtually no geopolitical risk premium in it. With violence continuing in the Middle East, while the Venezuelan and Nigerian governments deplete their foreign reserves, there is upside to the oil market.

Pain in the short term, gain in the long term. How to play it? I like Exxon, EOG Resources and although Anadarko lost a lot of money this quarter, I like it as well. With little new investment in Canada, I like Suncor and Husky Energy both of which have refining operations that have done well in the lower crude oil price environment. Rising oil prices and an increase in shale oil production will help the North American Pipeline operators so Plains All American, Sunoco Logistics and Magellan Midstream Partners look to have upside from here.

Commentary by Andy Lipow, president of Lipow Oil Associates.

Disclosure: Andy Lipow and Lipow Oil Associates do not own or trade any of the stocks mentioned above.