If you’re an owner of Exxon Mobil Corporation (NYSE:XOM), Chevron Corporation (NYSE:CVX) or any other oil and energy stock, you’ve got to be fairly happy after the past several weeks. The energy market has been en fuego since late January, rekindling a rally in oil prices that actually extends all the way back to early 2016. The current crude oil price of $71 per barrel is the highest price we’ve seen since October of 2014, when it was on the way down.
The $64,000 question is, can it last?
Probably not. Nevertheless, the trend remains pointed upward for the time being. And, the higher oil prices go now, the higher the low-point will be when they pull back.
A closer look at the bigger picture suggests this is a scenario that’s likely to be self-correcting or at least self-leveling in the near future.
Multiple Factors Driving Crude Price
Anyone reading this knows what the most recent leg of the oil rally is about: President Donald Trump’s decision to negate a deal that barred Iran from developing nuclear weapons in exchange for the freedom to sell lots of oil. In the absence of an active deal, sanctions are likely to be put back in place that will temper Iran’s crude oil output.
It matters because Iran is presently producing about 3% of the world’s oil. Crimping that flow could prove — theoretically — surprisingly disruptive to the global energy market.
That said, Trump can’t get all the credit/blame for soaring oil prices. Following the 2014/2015 implosion of crude oil prices, major producers like Russia, Venezuela and OPEC finally acquiesced and curtailed production in order to restore profitable crude oil prices. They may have gone further than some had hoped for at the time, yet the industry as a whole still remains unwilling to change its present course. Portfolio manager Brian Kessens at energy investment firm Tortoise explains “They’re being disciplined. They’re not increasing their drilling budget just because crude oil prices are higher.”
That’s keeping prices propped up against a backdrop of increased consumption, too.
Last year’s average daily consumption of oil reached 97.8 million barrels worldwide, up from 2016’s average of 96.2 million barrels. Analysts expect 2018’s average daily usage of crude to reach 99.3 million barrels. Dan Eberhart, CEO of oilfield services company Canary LLC, recently commented that “demand growth is soaking up the excess supply. People weren’t expecting the demand growth to be so robust.”
Is There an End in Sight?
Crude oil’s inherent short-term volatility aside, the energy market’s underpinnings imply more price increases, or at least stabilization around current levels. BK Asset Management director Boris Schlossberg explains: “I think the story is not going to go away. Even if the tensions kind of ease, they’re really boiling on the surface and I think that pretty much keeps oil prices elevated for the near term.”
The long-term, however, could be a different story.
Some industry insiders never really expected crude oil prices to move above $60, and for good reason. Anything below that price means it’s not worth the risk or expense to change the status quo. Anything above that price level encourages the development of new drilling projects as well as the reopening of shuttered ones that ultimately set the stage for too much supply.
For perspective, the aforementioned Chevron and Exxon Mobil break even when crude’s trading around $50. ConocoPhillips (NYSE:COP) says its level is an even lower $40 a barrel. It would take a decent, even if not huge, margin of safety to turn new oil spigots on though, and that wouldn’t likely happen to a wide degree at $60 per barrel.
At $70 though — if it persists — most of the key players in the energy market would have to consider taking the risk.
The irony? Though gas and oil giants have to have learned some sort of lesson regarding the risks of overproduction leading into 2014’s crude oil price meltdown, there’s no particularly strong assurance that they’re any more disciplined now than they were then. Oil players have, however, gotten very good at turning the spigots on and off quickly… a skill they didn’t quite have four years ago. That should help stave off the gross oversupply-undersupply problems of the past that ultimately led to painful price volatility.
Bottom Line for the Energy Market
There’s a not-so-insignificant detail that’s been glossed over in the geopolitical storm that materialized this week: Rolling back Iran’s limit on sales of crude from its current pace of 2.5 million barrels per day to an anticipated cap of 1.0 million barrels per day, will take several weeks to take into effect. OPEC and the world’s newest major exporter of crude, the United States, could adapt… preemptively.
The scenario is far more complicated than just Iran’s piece of the energy market though; there’s plenty of supply waiting to be drawn up out of the ground elsewhere. The crux of the complicated issue is a test of the global industry’s willingness to not over-react to a price surge that’s spurred more by emotion and assumption than actual supply/demand fundamentals. In that emotions are quick to ebb and flow and assumptions are often unwound by a different reality, it’s difficult to envision oil prices being allowed to rally much further for much longer… for a lot of reasons.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.