Only a few months ago, oil prices were plunging and a few of the usual suspects predicted they would keep plunging. Citigroup Inc. said prices could hit $20 (U.S.) a barrel, proving that investment banks never met a trend they didn't love.
The rout now appears to be over, with oil prices up more than 50 per cent since January, taking the international price close to $70. Of course, the forecasts are now being furiously rewritten because the trend is your friend. The bears have moulted into bulls with amazing speed.
Does this fresh trend have legs? A variety of factors suggest another sell-off is coming, if not immediately, then soon.
To be sure, the $45 (U.S.) Brent crude low, hit in mid-January, was unsustainably low. It caused too much pain for the high-cost crowd, notably the U.S. shale-oil companies. Unlike the oil sands players in Alberta, they have the ability to turn production on and off like a light bulb. Drilling rigs were pensioned off and production in Texas and North Dakota, the epicentres of American shale output, fell, if only slightly, reinforcing the bears' view that shale oil would be the main victim of the Saudi-inspired move to make a grab for global market share.
The hedge funds and the ETF mob couldn't resist an apparent bargain and gorged themselves on oil investments in January and February, sending the oil short-sellers packing. Stronger demand (thanks to the low price) and the economic recovery in Europe (thanks in part to the launch of the European Central Bank's $1.1-trillion quantitative-easing program) kept the price moving up. The recent slide in the U.S. dollar added momentum. Today, the fear that the oil surge will stoke inflation has triggered a massive bond sell-off in Europe and the United States.
But as the price climbs, so too, apparently, does Saudi Arabia's resolve to not see it return to triple-digit levels – oil was at $115 as recently as last June – for fear that it will keep losing market share to American and Russian producers. In November, at the Organization of the Petroleum Exporting Countries (OPEC) meeting in Vienna, Saudi oil minister Ali al-Naimi made it abundantly clear that the Saudis would not cut production to keep the price high; the non-OPEC producers would have to take on that job. Since then, the Saudis have not only kept their no-cut pledge intact, but they have actually boosted production to record levels – about 10 million barrels a day, up from about 9.7 million in November. While some of the extra production is feeding the new Saudi oil refineries, some is also leaking onto the world market.
Will Saudi Arabia boost production again? Possibly, though at some point it will bump into the upper reaches of its spare-production capacity. Still, there is no sign the Saudis will go back to their old production levels. That would constitute a cut, a word that has been excised from the lexicon of the Saudi oil industry.
At the same time, the American shale-oil producers will certainly become emboldened by the price rise, all the more so since they spent the winter months forcing their contractors and suppliers to charge less. With lower costs, many of them will enjoy fat profit margins even if oil stays below $100. Watch the U.S. drilling-rig count make a comeback, taking production up. That, combined with higher Saudi output, could easily remove some or all of the upward price momentum, though, as always, the question is: when?
Iran is, apparently, the one factor that oil traders and investors have not fully factored into their price forecasts. Iran has the third-biggest proven oil reserves among the OPEC producers, after Venezuela and Saudi Arabia. Its production and export capacity are enormous. But sanctions have strangled Iran's oil industry. Production fell to about 2.8 million barrels a day in 2014 from 3.6 million barrels in 2011.
If a nuclear deal is reached and the sanctions are eliminated, diluted or merely waived for a certain period, Iranian exports are bound to rise, perhaps even surge. Olivier Jakob, the former oil trader who is managing director of the Swiss oil consultancy PetroMatrix GMBH, says the Iranians might send 200,000 extra barrels a day into the export market as early as the last half of this year, with 500,000 barrels a day not out of the question not long after.
The Western oil giants play down Iran's potential to resume its status as an export juggernaut – it's in their best interests not to spook investors. But it appears a deal of some sort with the Iranians is coming. Note that Iran at the start of May hosted an international oil and gas conference to lure foreign investment into its ailing oil industry.
Beware the new bullish oil price predictions. Another outright price collapse seems unlikely. So, too, does yet another price surge. With the Saudis, the Americans and the Iranians all determined to produce more, there's a lot of supply about to hit the markets. A sustained price recovery seems unlikely.