By July 2, 2015 Read More →

World oil prices recovering, but for how long?

Oil prices not likely to break $65 in 2015

World oil prices have made a comeback from the low $40 per barrel mark in March, to around $60 in June. With U.S. oil inventories still at record highs, is this rebound in oil prices sustainable?

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Saudi oil minister Ali Naimi.

The spike in oil prices is closely linked to the number of rigs drilling for oil in the United States, which has become one of the largest producers in the world over the past few years. In November, there were close to 1,900 rigs drilling, but by the middle of June that number had plunged to around 830.

Many drillers simply can’t run their operations profitably with oil at $50 per barrel. U.S. oil production has generally been on the rise in the first half of this year; while oil producers closed some of their less productive rigs, they also ramped up production in their more productive ones.

However, energy analysts contend that as these more productive wells begin to run dry, the drop in drilling activity will start to dampen supply on the market. U.S. production will level off and even start to decline as the year unfolds, putting upward pressure on oil prices.

Currency movements are an often overlooked factor in the oil price rebound. Over the past year or so, the greenback has appreciated against the euro and other major currencies by more than 20 per cent. Oil is priced in U.S. dollars and a rapidly appreciating greenback makes it more expensive for oil-importing countries to buy product—so while oil prices have become cheaper for Americans, the drop is much less pronounced in Canada and other countries.

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Author Kip Beckman, Conference Board of Canada.

However, in recent weeks the U.S. dollar’s appreciation has stalled, and the currency has depreciated slightly against currencies such as the euro. This shift in sentiment toward the U.S. dollar has also helped boost world oil prices.

Despite the recent turnaround in prices, we remain cautious regarding the outlook for oil prices in the near term.

We expect West Texas Intermediate to gradually recover over the next few months, but remain below $65 per barrel even by the end of 2015.

However, there are risks—factors that could cause a pullback in oil prices include high U.S. inventory levels, higher production from Saudi Arabia, and the effect of higher prices on U.S. shale production.

Weekly U.S. commercial inventories of oil have declined in recent weeks, but remain close to 470 million barrels—around 15 per cent above the five‑year average. It will take time to reduce this excess supply, although the summer driving season will certainly help.

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Texas lost oil and gas jobs, mostly in the service sector.

A growing untapped supply of oil is another factor that has the potential to set oil prices back again. Fracking companies have continued to drill into shale oil deposits but have refrained from fracking the wells, which involves splitting the deposits apart with high-pressure water and chemicals to release the oil from the shale.

This suggests that there is plenty of additional supply ready to go as soon as prices become more favourable.

International developments in Saudi Arabia and Iran could also play a role in determining the future path of world oil prices. Late last year, Saudi Arabia’s oil minister announced that his country would continue to ramp up production even as prices fell to below US$50 per barrel.

As Saudi Arabia fights to maintain market share in the highly competitive U.S. market, production recently increased to over 10 million barrels per day—the highest level in three decades. While more of a long-term issue, the potential for higher supplies from Iran looms on the horizon if the ongoing negotiations over Iran’s nuclear program are successfully.

Iran was producing more than 4 million barrels per day before sanctions, designed to rein in the country’s nuclear program, led to a slide in production toward the end of 2011. Current production levels are slightly more than 3 million barrels a day, but a return to full capacity could have a dramatic impact on prices.

These factors pose risks to our view that world oil prices will continue to increase at a steady pace for the remainder of this year and into 2016.

While it is unlikely that world prices will sink back below $50 per barrel any time soon, a combination of international and domestic factors in the United States means that $100 a barrel oil will become an increasingly distant memory.

Kip Beckman is the principal research associate, economic services, Conference Board of Canada.

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