Why the rise in oil prices is temporary

There is so much oil out there that countries still don't know what to do with it

A nearly eight per cent jump in oil prices globally has led to reports appearing of oil prices bottoming out. There are various reasons for the price moving higher sharply over the last few days, but the big question remains: have oil prices have really bottomed out?

To answer that question, we will have to first look at the reasons for the rise and whether they are sustainable. The first phase of the rise was on account of news that there will be some kind of arrangement between OPEC (Organisation of Petroleum Exporting countries) and non-OPEC members on production cut in order to stall the fall in oil prices. Oil prices have fallen by 70% from their highs in mid-2014 as concerns of demand slowdown overtook the market.

 

Although many have welcomed the move of a meeting between the Saudi Arabia-led OPEC and non-OPEC members led by Russia, few expect anything meaningful to come out of it. The main reason being that OPEC is a divided cartel where nobody, including Saudi Arabia, follows the limits prescribed.

Also, reports say that Russia itself is producing oil at a rapid pace. Oil production from the country has touched an all-time high of 10.88 million barrels a day in January 2016, higher by 80,000 barrels in December 2015. Even Saudi Arabia is producing at record levels. Any deal to cut production will be objected to by other players citing the existing high levels of both the top producers.

The second reason for the rise in oil prices is the weakening of the dollar. US dollar index touched a seven-week low after New York Fed President William Dudley reduced expectations of the pace of future rate hikes. A weaker dollar makes commodities traded in the currency attractive.  Though there was bearish news for oil in the form of high inventory levels, the weak dollar led to speculative buying in the oil markets.

US Fed is also likely to slow down the frequency of rate hikes due to signs of a weakening economy. Demand for oil will continue to get impacted as US economy shows signs of instability after the first round of rate hikes.

Apart from the overall slowdown in global economies, oil market has to deal with increased supplies from Iran. Though Iran has decided to increase oil production by only 500,000 barrel a day, it is the inventory that the country holds in its floating tanks that is a cause of concern. Maritime data and analytics company Windward uses Big Data to track oil held in all ships in the Persian Gulf – including those that do not transmit their location. They estimate that Iran is hoarding 46 million barrels of oil; nearly triple of what they held in April 2014 is floating around.

Iran is in no hurry to increase its production and with years of sanction and tussle with Saudi Arabia, it is very unlikely that Iran will agree to cut its already low production. If anything, Iran would like to gain back its market share.

Further low prices have not yet started to impact economies though companies have started to feel the pressure. British Petroleum has reported record losses of $6.5 billion and has decided to axe 7,000 employees as low oil prices have started impacting the company.
 

Big oil companies themselves do not sound too optimistic on oil prices. Morgan Stanley says that willingness of producers to forward hedge at prices not above $40 per barrel is also capping prices.

Given the increasing supply and lowering demand scenario, it is highly unlikely that oil prices have found its bottom. Sal Umek of Energy Management Institute in New York sums it up well when he says that oil will make new lows before we start moving up higher. There is so much oil out there that you don’t know what to do with it.