Rebound of Oil Looking Less Sharp

Few weeks ago I wrote about how the price of crude oil may rebound sharply. It’s looking more and more likely that I was wrong. While oil prices will still rebound, it will be a slow one.

As I have stated in an earlier post, the current state of low oil prices is caused by a combination of falling demand from China and India, OPEC refusing to cut production, and increased U.S. production. And since the price drop, many shale drillers in the U.S. have cut production. With those in mind, plus the fact that in 2009 oil prices rebounded sharply, I believed that the same would happen again.

What I forgot to address the high amounts of oil currently in storage. With oil prices in record lows, many investors are jumping onto the oil storage game. According to an article on Reuters, traders are now purchasing oil for storage. The amount of activity in this sector have kept the price of oil futures low, no more than $60 per barrel in fact.

 

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Data on oil futures, taken from barchart.com (As of Feburary 11, 2015)

The chart above shows that futures on crude oil is being traded at as low as $63.68 per barrel, even for January 2017. That means buyers can secure crude for this price to be delivered in January 2017. This also means that traders can purchase oil at the current price of below $50 per barrel, and immediately sell a futures contract for some $60 per barrel. For those who can secure storage facilities or tankers, they can make a lot of money. But of course, this would attract more investors, which should drive up current oil prices while driving down future oil prices.

But what is interesting is that the current price of oil remained low. In fact, oil prices have dropped yet again in the past few days. (Wall Street Journal) This is because the supply of oil in the U.S. has not been cut as we were led to believe. According to the U.S. Energy Information Administration, the daily production of crude oil in the U.S. is currently at 9.2 million barrels, a number not seen since 1973. (1973 was shortly after the production of oil in the U.S. peaked) I will venture to guess that shale drillers claimed to be cutting production hoped to rouse speculators into buying more oil, thus driving up the price. But since oil drilling requires huge amounts of sunk costs, especially true for drilling in shale, these companies are reluctant to cut production after investing so much.

So as it currently is, the glut of oil will continue to grow, at least until existing oil wells are depleted. But even then, we will have huge amounts in storage. Such that the price of oil will remain low for the foreseeable future.

2 thoughts on “Rebound of Oil Looking Less Sharp

  1. Justin Lee

    Good argument with supply of oil instead of expectation. The price index should not be adjusted in the context of “what it should be” comparing to past price. This argument, I believe, people use it a lot in the context of stock market. The expectation, in the context of oil price, does not seem to work.

  2. Hojoon Kim

    I really like the point where you mention that buyers can secure oil at cheaper prices and sell a futures contract for a huge profit. However, it would be a bad strategy if the price of oil will keep falling for a few years as the members of Opec and other oil suppliers have no intention to lower their production level.

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