Why Oil May Hit $50 This Summer

Thu, Apr 7, 2016 - 8:03am

US and Canadian oil production rose at a parabolic rate for 4 years ending in June 2015. While Canadian supplies may have plateaued and remain near record levels, US output began a longer term decline that we are certain will continue throughout 2016 and beyond.

A 10% US supply drop will turn into a 15% reduction by year end 2016 as the rate of daily production falls from 9.6 million barrels a day (mbd) to 8.1-8.4 mbd. More impressively, almost a third of the parabolic surge in supply over the previous 4 years will have been erased.

This inventory drawdown and normal upward seasonality will help boost oil prices into the 2nd and 3rd quarter as we have been forecasting. While the peaks of $107 in 2014 and $145 in 2008 will not be touched for a long time, we still see prices moving above $50 this summer.

Oil Inventories Will Shrink Into September

US oil production typically declines beginning in April as gasoline and distillate mixtures are prepped for the high demand summer driving season. With US production declines likely to continue subtracting an additional 15,000 to 22,000 mbd on average every week going forward, we would expect a stronger than normal oil stockpile reduction to bottom in August/September.

Pyrrhic Victory for Saudi Arabia

Chalk up a small victory for Saudi Arabia as they achieved their goal of enacting a multi-year decline in US oil exploration and temporarily gaining some market share. The Saudi victory is pyrrhic since they will continue to suffer enormous 60% budget revenue shortfalls from the 2-year oil price drop while desperately spending more money than ever fighting a proxy war in Yemen for their Sunni brethren. Prices will have to remain in a sweet spot below /barrel and above for years to come to prevent a strong resurgence of the oil fracking sector and to maintain a stable oligarchy.

Our 2015 forecast for oil prices to fall until the seasonally strong period began in February/March 2016 has come to pass. We have been negative on oil since the summer of 2014 and have shifted this February to short- to medium-term bullish and longer term neutral as prices carve out a trading range this year. If a global recession occurs later this year then oil and stock prices will contract sharply to new multi-year lows. Otherwise our forecast for more stable oil prices into 2017 remains. At this juncture, we don’t foresee a recession as the US economy bottomed in conjunction with oil in February and appears to be headed back to the “new normal” of 2% growth.

Watch Out for Junk!

Oil prices have been abnormally influencing high-yield junk bonds since 2014. Just as our last newsletter talked about oil as a great Leading Economic Indicator, it is also a short-term stock market barometer. Using high-yield bonds as a proxy for risky oil stock debt, we often get very accurate stock market sell indications when junk bonds negatively diverge with stock indices (S&P 500 Index). Last July and again in December these negative divergences generated strong short- to medium-term 15% sell signals for stock investors. At the recent highs from March 30th to April 4th this indicator has again signaled at least “moderate” sell-side risk for stocks.

This Sell would be considered valid as long as oil prices remain beneath .66 a barrel on a closing basis and HYG (below) stays under its March top. Above that price oil and junk bonds would be supportive of higher US stock Indices, if not new record highs.

Related podcast: Don Coxe Says Low Oil Prices Will Persist As Long As the Saudis Are Frightened of Iran

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