Oil prices are rising at a historic pace, and they are likely to get even higher and more volatile

Published Fri, Jun 25 202112:58 PM EDTUpdated Fri, Jun 25 20211:42 PM EDT

Patti Domm @in/patti-domm-9224884/@pattidomm

Oil prices have doubled since last fall, and they are expected to continue to move higher in a volatile and unusually bullish period for the commodity. While there are some calls for $100 oil, not all industry analysts agree the crude price per barrel will soon reach that milestone or stay there for long if it does. But they do agree there is more than one wildcard that makes calculating the future price very difficult. Those unknown factors include the fate of U.S. oil producers, how "OPEC+" uses production controls and how demand recovers in places hard hit by the pandemic, like India. The market is currently experiencing a surge in demand but production is not running at the same pace, and inventories are falling. The U.S. was the world's largest oil producer prior to the Covid-19 pandemic, as independents and majors drove shale production to higher and higher levels. The U.S. had become a major energy exporter and was viewed as a swing producer with strong influence on global oil prices. OPEC driving price again But as the pandemic ebbs and demand returns, the U.S. industry is no longer what it was and is facing constraints that make a major boom in shale less likely. "In 2015, people were writing OPEC's obituary. OPEC is back with a vengeance," RBC chief global commodities strategist Helima Croft said. OPEC+ — which is made up of OPEC and non-OPEC oil producers — meets July 1. It is expected to continue to return supply to the market, albeit slowly. About 1 million barrels are expected to come back on line in July. The world is currently producing less oil than is being consumed. "One thing that's new is we're once again beholden to Saudi Arabia. We've seen them flex muscles in both ways. They're going to claim the market is well supplied and it's all speculation," said John Kilduff of Again Capital. "Historically, there was a supply response," Kilduff said. "The last time it was U.S. shale waiting in the wings. I think the problem we're having is we're going to suffer a period of much higher oil prices until the cavalry can ride to the rescue from the Permian." Oil prices are at their highest levels since the second half of 2018. West Texas Intermediate futures were at $73.61 per barrel, after closing Thursday at $73.30 a barrel. International benchmark Brent was above $75.62 a barrel. WTI is up 51% this year and has gained 24% for the second quarter. The Energy Select Sector SPDR Fund ETF has gained 45% year to date. Quarter to date, it's up 12.5%. "I think the upward biased price is driven by a pretty disciplined OPEC and the lack of spending that's been ongoing in the U.S.," Pickering Energy Partners chief investment officer Dan Pickering said. "It's two reasons. One I think is there's just been less cash to invest and the other is shareholders are demanding more of the companies," Pickering said. "They are forcing companies to drill less and return more of the cash in dividends, share repurchases, and debt paydowns." Companies are also under pressure from shareholders. Exxon Mobil, for example, lost three board seats to activist firm Engine No. 1, a firm that wants the company to reconsider its position in a world aiming at net-zero carbon. Chevron shareholders voted against management on a key climate proposal, and Royal Dutch Shell was ordered by a Dutch Court recently to move quicker to reduce carbon emissions. "If we don't have investment and demand is good, then you're going to have to end up with a supply dislocation.," Pickering said. "Prices are going to have to go up enough to kill demand. That situation may not be 2021... but it could be 2023 or something like that. The challenge for the industry is nobody wants the product, but everybody wants the product." More immediately, prices are rising, and RBC strategists say the groundwork has been laid for a bullish period, following low prices and a supply glut during the pandemic. "While we see further upside, near-term price gyrations are to be expected. The pace of the current price rally is historically rare" they said in a recent report. They added the doubling of prices in eight months is unusual, and it has happened at the current pace only three times over the past two decades, with all of those instances between the period of peak and then trough oil prices between 2007 and 2009. Oil reached its all-time high near $144 per barrel in 2007. Oil collapsed in an unprecedented fashion last year, when demand dried up overnight and prices turned negative. Just before the pandemic shut down the economy in 2020, U.S. oil production was peaking at just above 13 million barrels a day. It is currently holding steady at just about 11 million barrels a day. How much and how quickly the U.S. returns production is a source of much debate in the market. Analysts say private companies have been faster to return production, but there are signs other producers are beginning to as well. Some estimates put the return of U.S. barrels at 500,000 to 700,000 over the next year. But Citigroup sees a stronger return for shale. For that reason, it does not expect a sharp spike in prices. "Next year, we see U.S. production growing by 1.3 billion barrels a day," Citigroup energy analyst Eric Lee said. "We're very bullish this year, and we don't want investors to mistake it for a new bullish super cycle," he said. Lee said the most bullish of investors do not expect as strong a recovery in shale. He said Citigroup expects prices for Brent could touch a high of about $85 per barrel in the fourth quarter, but they should average more like $78 a barrel in the quarter, up from an estimated $77 per barrel average in the third quarter. Citi strategists expect Brent to then average $67 per barrel in 2022, down from an average of $72 this year. "We don't think we'll get to $100," Lee said. "Triple digits just seems ridiculous to us. Part of it is because demand growth...I think demand growth is going to underperform once we get out of the recovery," he said. The demand case But for now demand is strong and expected to get stronger into next year, particularly as air travel returns. World oil demand is estimated to average about 96.4 million barrels a day this year, up about 5.4 million barrels from last year, according to the International Energy Agency. Demand next year is expected to average a more normal 99.5 million barrels a day. By the end of 2020, the IEA sees demand exceeding pre-Covid levels. "Demand is really outperforming, even if you're looking at mobility data in India and elsewhere," Lee said. "In the U.S. and China, it's very strong, and you add to that trade growth is really picking up." Lee said he expects the world to continue to draw from inventories through this year. "Because demand is starting to pick up beyond 2019 [levels] at the very least, you're getting back to the top end of demand. Now you're back in demand growth mode for at least the next year or two," he said. RBC strategists point out that U.S. inventories, arguably the most watched in the world, were trending at normal levels as recently as two months ago. But after a number of significant drawdowns, they are trending at a very low rate, according to an important industry metric. The industry gauges supply based on a five-year average, and RBC strategists note that even before this week's more than 7 million barrel drawdown, the deficit to that average reached a sizeable 24.9 million barrels. That was in part due to the elimination of what was a 30 million barrel deficit in the Gulf Coast, where crude was stockpiled during the pandemic. Prior to this year, crude stocks have reached a seasonal deficit of 10 million barrels or more just three times in the past 15 years and have not been this large since oil prices spiked in 2008, RBC strategists said.

Oil pump under the blue sky with beam pumping unit in the oil field.

Zheng Zaishuru | iStock | Getty Images

Oil prices have doubled since last fall, and they are expected to continue to move higher in a volatile and unusually bullish period for the commodity.

While there are some calls for $100 oil, not all industry analysts agree the crude price per barrel will soon reach that milestone or stay there for long if it does. But they do agree there is more than one wildcard that makes calculating the future price very difficult.

Those unknown factors include the fate of U.S. oil producers, how "OPEC+" uses production controls and how demand recovers in places hard hit by the pandemic, like India.

The market is currently experiencing a surge in demand but production is not running at the same pace, and inventories are falling.