Oil rally spiked: What’s making crude prices drop after galloping over the $40 hump

After a six-week rally that saw crude push to the US$40 market, prices took a sharp turn Tuesday on rising U.S. inventories that implies markets have not yet designed a full recovery.

“It’s not really an upright line up, there is going to be lots of resets before we move structurally higher at the tail end of the year,” said Jon Morrison, analyst at CIBC World Capital Markets Inc.

Prices for Brent crude have risen an astonishing Half since their Jan. 20 low and had reached a three-month high to US$41.43 Tuesday morning, before receding below US$40. U.S. West Texas Intermediate futures also hit US$38.28 – its highest point this season – before slipping to US$36.50.

What’s incredible is that US$50 has become the brand new US$100.

CIBC expects WTI prices to average US$45 this season and US$65 next year because the spate of declines in Russian and U.S. production and powerful China, India and American consumption bode well for that commodity.

Not everyone is convinced. Goldman Sachs, an influential oil soothsayer, poured cold water over the rally inside a report Tuesday, citing continued oversupply.

“Only a genuine physical deficit can create a sustainable rally which is still months away should the behavioural shifts created by the reduced prices in January and February stay in place,” the brand new York bank said.

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But a big change of tone one of the Gulf states that dominate OPEC suggests US$50 has become the specified level for producers which had committed billion of dollars in their domestic economies throughout the era of US$100 oil, said RBC Capital Market’s Helima Croft.

“What’s incredible is that US$50 has become the new US$100,” Croft, RBC’s New York-based global head of commodity strategy, said within an interview. “It would still require borrowing (by Gulf states), and some types of rationalizing expenditure, but US$50 is what they believe may be the minimum they have to cope with this.”

Oil firmed up in recent weeks after OPEC proposed to freeze output at January levels gained momentum, Russian production declined and more realistic assumptions on rising Iranian output.

The United Arab Emirates – an influential Saudi ally in OPEC – fuelled the rally on Monday, noting that “it doesn’t make sense at all for anyone to increase production.”

However, a Kuwaiti senior official remarked that his country’s participation depends on a reluctant Iran adhering to the freeze deal partly triggered the sell-off .

“If the marketplace doesn’t take the freeze seriously or there are spoilers, there would need to be more meaningful market measures,” Croft said. “The freeze is only important whether it’s a prelude to more steps.”

While OPEC flip-flops and invokes imaginary declines in production, supply using their company producers is set to contract.

The U.S. Department’s latest forecast shows output from the “Big Four” shale plays – Eagleford, Bakken, Niobara and also the Permian – will visit around 93,000 barrels each day in March and 105,000 bpd in April.

“The non-OPEC oil sector has become responding faster due to further deep cuts in upstream investment, that are feeding through as faster declines, led by U.S. tight oil,” Wood Mackenzie said inside a report Tuesday. “This re-adjustment from the fundamentals should result in a stronger price environment.”

The energy consultancy forecasts U.S. production to say no by around a million bpd this year to 6.5 million bpd, having a sharp upturn not on the horizon if prices recover.

“It’s harder to increase than it’s to ramp down, due to the layoffs over the past Twelve months,” said Alex Beeker, Houston-based analyst at Wood Mac.

“Lots of individuals are leaving the and as prices jump it’s going to take time to obtain the crews into the field. It will not happen overnight.”

North from the U.S. border, active oil rig count stands at 103, 1 / 2 of its level last year, with Canadian conventional production set to drop 125,000 bpd this season, based on CIBC.

However, oilsands production will rise 250,000 bpd leaving Canada among a small number of producers raising output this season.

While supply tapers off, global demand remains robust, with China’s crude oil net imports reaching a record eight million barrels each day in February.

There will likely be a few more setbacks on the way, but there is a sense that the summer driving season should lift sentiment as excess supplies melt.

Or as Barclays Capital puts it succinctly in its report Tuesday: It’s “the end of winter.”

yhussain@nationalpost.com

Twitter.com/YAD_FPEnergy