Events pushing oil prices higher

It’s not something energy execs are usually eager to broadcast, but bad news is often good news for oil prices, and that’s certainly the case right now.

U.S. light crude prices surged to a six-month high of US$47.72 a barrel Monday on the New York Mercantile Exchange, more than 80 per cent above the 12-year lows of $26-plus set in early February.

The three-month-long oil price rally, which many expected to run out of steam in the $40 range, has instead gained speed. The key reason: unexpected supply disruptions that are shrinking the global supply glut faster than expected.

Even Goldman Sachs, which warned not long ago that oil prices could drop to just $20 a barrel, has abruptly changed its tune, turning moderately bullish.

The catastrophic wildfires that forced producers to shut in more than a million barrels a day of oilsands output are the most prominent example. It’s still unclear how much of that production is back online, but the curtailments are expected to be short-lived.

Although the oilsands shutdowns are strictly precautionary, since no energy facilities were actually damaged by the fires, the loss of production is having a very real impact on Alberta’s economy.

According to a Conference Board of Canada report to be issued Tuesday, the disaster in Fort McMurray, which damaged or destroyed some 2,400 buildings and forced 90,000 residents to flee the area, will slash Alberta’s gross domestic product (GDP) by a full percentage point in the current quarter.

“In total, we’ve assumed that lost production will average about 1.2 million barrels per day for 14 days. This would translate into roughly $985 million (Cdn) in lost real GDP, or 0.33 per cent of Alberta’s projected GDP in 2016,” the Conference Board says.

It expects the impact to be reversed next year, however, as rebuilding efforts in Fort McMurray get underway. The board figures that should boost Alberta’s GDP by $1.3 billion or 0.4 per cent in 2017, with further gains likely in 2018-19.

But right now, the oil market’s immediate focus is on mounting supply cuts, not just in the oilsands, but in other key oilproducing regions.

Ongoing turmoil between warring factions in Libya has curtailed its oil exports. In Nigeria, attacks on energy infrastructure operated by Royal Dutch Shell and Chevron have shut in more than half a million barrels a day of supply.

At the same time, U.S. oil production — which peaked at 9.7 million barrels a day in April 2015 — has continued to shrink in the face of low prices. It’s currently around 8.8 million barrels per day, and is expected to sink further. The U.S. Energy Information Administration forecasts a drop of 113,000 barrels a day next month from seven key U.S. shale oil plays, reducing their total production to just under five million barrels a day.

Latin American nations that have relied on crude exports to sustain their economies, are also struggling to maintain production in a period of low prices. Venezuela, widely regarded as the biggest economic basket case in the Western Hemisphere, is in complete turmoil.

“Among all Latin American countries, Venezuela is the most vulnerable to low oil prices. Oil accounts for 96 per cent of its exports and is the economy’s main source of foreign exchange,” says New York-based Eurasia Group in a recent commentary.

“Production has so far remained stagnant, but the government needs to invest about $15 billion US per year to maintain current production ... and mounting problems will probably lead to a decline of 100,000 to 150,000 barrels per day this year.”

Recent moves by oilfield service giants Halliburton and Schlumberger to curtail operations in Venezuela may accelerate its production declines in the months ahead, Eurasia adds.

While questions mount about when or if disrupted crude oil supplies come back onstream, the outlook for global oil demand continues to strengthen.

Last week, the Paris-based International Energy Agency boosted its world oil demand projection for 2016 by 100,000 barrels a day, to 95.9 million b/d. It attributed the revised outlook to stronger first-quarter oil demand in China and India. Indeed, the IEA says India is “taking over from China” as the top growth market for oil worldwide.

“Soaring demand, in part caused by low prices and falling non-OPEC oil output, is sending oil back on an upward trajectory,” says Phil Flynn, senior market analyst at Price Futures Group, Bloomberg reports. “This comes as the U.S. oil rig count plunges for the eighth week in a row.”

Despite Monday’s market fireworks and the widespread improvement in sentiment in oil markets, it’s important to bear in mind that U.S. crude oil stockpiles remain near all-time record highs. So it’s not as if the U.S. — or any other major oil consuming market — is in danger of facing a shortage of oil any time soon.

But oil prices aren’t merely subject to the laws of supply and demand. Speculators play a big role in setting futures prices, and often drive prices to extremes, both at the bottom and at the top of commodity cycles.

Whether this rally has run too far too fast remains an open question. Some U.S. producers, such as Chesapeake Energy, are already hedging their bets by locking in higher prices through various financial instruments, Bloomberg reports.

We’ll find out soon enough whether they’re ahead of the curve, or behind it.