Good times ahead for oil — or is there a catch?

Crude oil futures prices soared over 7% last week to close at $38.52 a barrel. Oil futures traded above $39 on Friday as the International Energy Agency released its Monthly Oil Report for March with a bullish outlook for prices.

In the report, the agency suggested that just maybe we have seen the bottom for oil prices in this cycle. The report was full of positive language – citing “possible action by oil producers to control output; supply outages in Iraq, Nigeria and the UAE; signs that non-OPEC supply is falling; no reduction in IEA’s forecast of oil demand growth, and recent weakness of the U.S. dollar.” What more could energy traders want?

The only problem is that the IEA also hedged its view somewhat, suggesting that the recovery in oil prices in recent weeks should not “be taken as a definitive sign that the worst is necessarily over.” The agency thinks it will be well into 2017 before the oil market achieves balance, and that depends on both supply continuing to contract while demand does not fall short of expectations. On that front, the IEA points to a disturbing drop in demand in 2015’s fourth quarter to only 1.2 million barrels per day from the 2.3 million barrel-per-day increase estimated for the prior quarter. The fourth quarter is traditionally a solid period for energy demand as it encompasses the early phase of Northern Hemisphere winter demand.

Oil price volatility has truly been the watchword so far this year. In the first 10 weeks of 2016, oil futures prices have been down 28%, up 17%, down 22%, and now up 47% through Friday. Are you suffering from whiplash watching the price moves? The amazing thing is that this pattern mirrors almost exactly the pattern of price changes experienced during the first half of 2015. While it took 26 weeks to achieve the price moves we’ve seen so far this year, not only are the percentage moves relatively similar, but the absolute dollars per barrel changes are as well. The big difference this year is that we are actually witnessing domestic oil output falling, and certainly the nation’s rig count is substantially lower than during last year’s first six months putting further downward pressure on output.

Last year, oil production proved much more resilient than anyone expected. So will 2016 see production truly collapse, or will the decline prove to be more modest, confounding the forecasters once again? The IEA has already baked into their forecasted industry recovery a lower demand growth than experienced in 2015. But after warning about what happened to fourth quarter consumption, one should remain cautious about the outlook, especially given weakening Chinese oil demand. Let’s hope the light at the end of the tunnel that the IEA claims to see doesn’t turn out to be a freight train!

About the author

G. Allen Brooks

G. Allen Brooks is a 40-year veteran of the energy and investment industries, serving as an energy securities analyst, an oilfield service company manager, a consultant to energy company managements and a board member of several oilfield service companies. He is the author of the highly regarded energy newsletter “Musings From the Oil Patch” that interprets trends within all sectors of the energy business.

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