Oil prices won't keep plunging because US drillers can't meet demand, analysts say

Key Points
  • Oil prices have been under pressure for much of the last two weeks, but the rout is unlikely to last long, analysts say.
  • Supply and demand in the oil market are finely balanced, and surging U.S. output might not be enough to offset supply disruptions in Venezuela and Iran.
  • Oil market fundamentals and OPEC policy could support oil at roughly $70 a barrel or higher, analysts say.
Oil price decline 'temporary', says pro

U.S. crude prices sank on Thursday after a brief rally in the previous session, but analysts say the recent slump in oil prices won't last much longer.

In the five sessions through Tuesday, U.S. crude futures fell from more than $72 a barrel to just under $67 a barrel, shedding 7.6 percent. International benchmark has tumbled as much as $6 a barrel from its recent 3½-year high of $80.50, but has rebounded to about $78 a barrel.

"I think it's temporary. I think the fundamental picture is still really strong. The market's getting a bit dislocated right now based on a risk-off sentiment," Tamar Essner, director of energy and utilities at Nasdaq Corporate Solutions told CNBC's "Squawk Box" on Thursday.

Essner said the market's aversion to risk has been stoked by concerns about the Trump administration's looming trade wars and questions about the integrity of the European Union, which have caused the U.S. dollar to strengthen. A stronger greenback makes commodities sold in U.S. dollars more expensive to holders of other currencies.

Oil prices were already heading lower on recent reports that OPEC, Russia and several other producer nations could soon begin winding down their 17-month-old deal to cap output. That agreement has drained a global glut of oil and helped balance the market, but it's now under review due to falling Venezuelan output and renewed U.S. sanctions against Iran, OPEC's third-biggest producer.

Oil market is ignoring the big Iran story, says strategist

Venezuela's output has fallen by about 500,000 barrels a day this year and could drop by the same amount by year's end, Essner said. Meanwhile, U.S. drillers would struggle to boost output by more than 1.2 million barrels a day.

"So we need every last barrel of those supplies to take us to where we need to balance the market," Essner said.

Underscoring Essner's point, oil futures reversed some of their losses on Thursday after weekly data showed a big drop in U.S. crude inventories.

American drillers that specialize in freeing crude oil from shale rock formations are facing worker shortages and limited pipeline capacity in western Texas. At the same time, these drillers are focused on returning value to their shareholders, rather than plowing revenue into new production.

"Shale is not Superman," Helima Croft, global head of commodities strategy at RBC Capital Markets, told CNBC earlier in the week.

Shale drillers face yet another hurdle to upping output, according to Essner. Many agreed to deliver oil to customers at prices far below today's levels — a practice known as hedging — and set capital spending plans assuming prices would average about $60 this year.

"They're sort of locked in, and when you look at the slope of the futures curve, it's going downward. That makes it harder to hedge production at attractive prices for further-out years," Essner said.

Oil prices are likely to settle around $70 per barrel, said Essner, who believes futures rose to that level largely on supply-and-demand fundamentals.

Oil prices driven more by financial markets than physical ones, says oil expert

OPEC would likely intervene if oil prices threatened to drop below the $70 per barrel mark, according to Sadad Al-Husseini, founder and president of Husseini Energy Company, on Wednesday.

"Clearly $80 a barel was way too high and was going much higher, he told CNBC's "Squawk on the Street" on Wednesday. "On the other hand they don't want to lose the floor. Dropping below $70 would be clearly too low, so they're trying to coordinate their strategies ahead of the OPEC meeting on June 22."

Husseini said the physical market — where barrels are bought and sold to satisfy actual demand — are "pretty well balanced." For that reason, there's little urgency for OPEC to change its policy until it assesses how far Venezuelan output will drop and to what degree U.S. sanctions will take Iranian barrels off the market.

"There is spare capacity. OPEC can if necessary add production, and if that gets called for, I'm sure the ministers will do that. They just don't want to get ahead of themselves because right now there isn't an issue," he said.

U.S. production may be about to top out, but the industry should work through the bottlenecks by next year, he said. Canada and Brazil are also set to increase output, he noted.