There’s been a lot of speculation recently about the future direction of oil and gas prices after the spot price of West Texas Intermediate Crude Oil rose to $42.12 per barrel on April 12, from a recent low of $26.19 on February 11 of this year.
Many of the talking heads who appear regularly on broadcast financial shows, have led financial market participants to think that petroleum prices will continue to rise during the months ahead. I, however, expect oil and gas prices to trade in a narrow sideways range over the next several months. That expectation is based primarily on the following.
(1) The worldwide supply of oil is currently substantially higher than the demand for oil and is likely to continue to remain above demand for at least the next few months.
That’s because improvements in the use of hydraulic fracking processes – in methods used to extract oil and gas from shale rocks – will likely lead to further increases in the worldwide supply of oil. Additionally, on-going economic slowdowns in most regions of the world will likely lead to further declines in the demand for oil. Any such increases in supply… and decrease in demand… would put downward pressure on the price of oil.
(2) Although the value of the U.S. Dollar declined considerably against other currencies (from December 2, 2015 to April 12 of this year), it will likely rebound over the next few months.
That’s because U.S. interest rates will likely remain higher than interest rates in most other regions of the world. This is mainly due to the fact that Central Banks in Europe, Japan and China will likely continue to reduce lending rates in efforts to stimulate the economies in which they operate, while the U.S. Federal Reserve will likely maintain lending rates near their current levels.
In the event those developments were to occur, foreign investors would likely increase their purchases of U.S. debt securities in efforts to generate higher returns on their holdings of debt securities. In doing so, those foreign investors would need to exchange larger amounts of their currencies for the dollar, which would then lead to increases in the value of the dollar, relative to those countries’ currencies. Such an increase would likely put a ceiling on the price of oil. That’s because crude oil is priced in U.S. Dollars.
(3) Recent efforts by some of the world’s major oil producing countries to curtail the production of oil failed, and economic and political factors in those countries suggest that any such efforts during the months ahead would also fail. Hence, the worldwide supply of oil is likely to remain near its current level over at least the next few months.
(4) Although the number of rigs drilling for oil declined substantially over the past 17 months (in response to a $74 or 68% decline in the price of West Texas Intermediate Crude Oil from June 20, 2014 to April 4 of this year), the number of such rigs would likely increase in the event that crude oil prices were to remain near their current level of around $40 per barrel.
Any such increases in the number of rigs drilling for oil would likely lead to increases in the supply of oil, relative to the demand for oil, and would therefore, lead to reductions in the price of oil. However, because oil drilling companies usually do not increase their number of rigs that drill for oil until 2-3 months after the worldwide price of oil rises, the supply of oil will likely decline somewhat over the next couple of months due to recent reductions in the total number of rigs drilling for oil.
Over the next couple of months, those reductions will likely put a floor of support on the price of oil, as the demand for oil will likely rise a bit, relative to the supply of oil.
Because of the factors discussed above, my firm and I are confident that oil and gas prices will remain near their current levels through the remainder of 2016. Therefore, I encourage you to pay little attention to anyone who claims that oil and gas prices are going to rise substantially during the months ahead.
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David Frazier is President and Chief Market Strategist of Frazier & Mayer Research, LLC, an independent investment research firm that offers customized research and analytical services to registered investment advisors, hedge funds and high net-worth individual investors. You can check out his latest insights at: www.investorsmonitor.com.