In spite of agreeing to production cuts last November, crude oil prices, as recently as last week, were back to where they were prior to OPEC's ineffective "agreement." There are plenty of things that I dislike about today's oil markets but there are also plenty of things that make me like it in the next six to 12 months.
The oil market was impatient waiting for world oil inventories to decline and had become besides itself in bearishness. Ever increasing production from big producers like Libya and Nigeria and the U.S., and even small producers like Ecuador, created the impression that supplies would continue to rise. Iran's desire to increase production from 3.7 to 4 million barrels per day by the end of the year hasn't helped. Meanwhile, some OPEC and non-OPEC producers will meet in Abu Dhabi next week to discuss production compliance issues, and all eyes will be on Iraq, which has been notorious for producing over its allotment this year.
This seeming barrage of bearish news has actually made me bullish on oil prices.
Here's why. The news of further production increases is priced into the market. Libya and Nigeria are back, but it is unlikely to see more production out of them. In fact, it would not surprise me to see some unrest in each country that takes oil off the market. Venezuela production continues to decline thanks to the political unrest in the country.
The market's pricing has little to no geopolitical risk premium in it.
The Trump Administration may react to the July 30 Venezuela vote to overhaul its constitution by banning exports to and imports from Venezuela into the USA. While this does not take oil off the market, it will be bullish for pricing as Venezuelan crude will seek sales in Europe and Asia while U.S. refiners seek additional supplies from the Persian Gulf and elsewhere. It will take six to eight weeks for the world refining system to rebalance.
Crude oil and petroleum product inventories are declining. In the US, crude oil inventories have declined over 50 million barrels (from 535 to 483 million) since the end of March and another 15 million has come out of the Strategic Petroleum reserve this year as refiners ramped up runs to meet demand. Gasoline inventory is down 28 million barrels since its peak in February.
In addition, demand does not look so bad anymore. For the balance of 2017, it looks like U.S. gasoline demand will be on a par with 2016 levels. In fact the Energy Information Administration just reported that May 2017 gasoline demand is up 1.6 percent from May 2016 while distillate demand was up a whopping 6.0 percent. The previous decline in gasoline demand appears to be a first quarter phenomenon. The International Energy Agency has forecast world oil demand to rise to 1.4 million barrels per day in 2017 versus 2016 with continued draws in OECD inventories in June.
With all of these different factors affecting the market, I now expect Brent crude to reach $53 to 55 by early 2018 and I can see West Texas Intermediate reaching $51 to $53. Capping the rally will be interest from oil producers to hedge their future production.
The beneficiaries of the price rise include oil producers in the Permian basin. Occidental (OXY), EOG Resources (EOG) and Diamondback Energy (FANG) should see gains. I like the companies that transport oil: Plains All American Pipeline (PAA), Magellan Midstream Partners (MMP) LP, Nustar (NS) and Enterprise Products Partners (EPD).
If the United States were to ban the export and import of crude oil and petroleum products to and from Venezuela, shipping companies would be the biggest beneficiaries. Five day voyages between the two countries would be replaced with voyages of 15 to 25 days to and from Europe and Asia as short haul supplies are replaced with more distant sources.
The beneficiaries of these bans would be companies such as Teekay (TK), Frontline (FRO), Tsakos (TNP) and Nordic American (NAT).
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.
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