The Supply Glut is Over

$30 oil is no longer a possibility

Commodities, Supply Glut, is Over, fx trader, forex

15 Jul 2016

The oil price has been driving higher since establishing a multi-decade low in February. Strong gasoline demand and a sharp decline in United States shale production helped crude rebalance and get the bulls back into the market. Supply disruptions in Canada and Nigeria pushed the market above the $50 level, well into positive territory. However, this may attract struggling shale producers to increase production and once again threaten the uptrend.  

The recovery in the oil market is due to strong gasoline demand. United States highway traffic data is at levels not seen since the early 1990’s, as drivers take advantage of lower prices at the pump. The weekly Department of Energy oil reports, an indicator of supply and demand, have consistently shown reductions in gasoline stocks. However, recently inventories began to increase. This may be a minor anomaly or the beginning of a negative trend. If gasoline stocks continue to increase traders will start to question whether demand within the United States has peaked for the year. This scenario has the potential to limit the impressive gains made this year and pull the market down. Aside from the increase in gasoline stocks, oil rigs have been coming back online.

As the price of crude plummeted during the first months of the year, a number of upstream operators (oil exploration and production companies) filed for bankruptcy as they were unable to sustain sub-$40 oil. Due to this, the total number of operational oil rigs declined to the lowest level on record. As oil wells are taken offline the flow of oil decreases and prices tend to rise. The companies that survived when oil was below $40’s are now starting to bring wells online that are profitable at $50’s a barrel. The reason for this is that they are burdened with debt and may seek out any opportunity to cover their short term debt obligations. This is a worrying sign for a rally that is built on strong gasoline demand and a reduction in United States shale production. Aside from bringing dormant wells online there are a number of drilled but uncompleted wells, referred to as DUCS, scatted around the country. These were drilled when the going was good and abandoned by upstream operators when the price was at its nadir. At the current price level, it may be financially feasible for companies to complete these DUCS and bring them online. The result would be a dramatic increase in production and a sharp drop in the price. The market is unlikely to drop below the $40 level as supply disruptions have supported crude and look to continue for the foreseeable future.

Commodities, Supply Glut, is Over, fx trader, forex Gasoline

Chart 1