Fundamentals Catching Up To Sentiment, But Clouds Still Haunt The Outlook

Crude Oil:

Crude oil prices are treading water, but that is not surprising given their significant rise since late last year. While momentum helped propel prices up earlier this year, seldom does it continue in a straight line. Just like runners, price moves need to stop and take a breath at times. Sometimes that breath occurs as some market news causes oil prices to drop, scaring people that the price rise is over. Price corrections are positive, if the long-term trend is up, which appears to be the case now.

The question for oil prices now is whether supply growth overwhelms the demand increase. The corollary is rising demand rapidly shrinking inventories and spiking prices higher. That is a less desirable scenario for OPEC+ members who wish to see a sustained increase in oil prices, but not at a pace or to a level that chokes off demand growth. To gauge the future for oil prices, we need to pay attention to the two primary sources of global oil supply – OPEC+ and the United States.

The outcome from the recent OPEC meeting signals that the accommodation between Russia and Saudi Arabia seems to be working. By allowing Russia to slowly increase its exports, Saudi Arabia has solidified market prices. The new agreement enables Saudi Arabia to begin adding additional supply to the market, but at a measured pace that should not depress prices. Adding 350,000 barrels per day of new supply in May and June, and 450,000 barrels in July, when demand will be seasonally strong, should sustain global oil prices around current levels.

The OPEC plan reflects Saudi Arabia’s concern over global oil demand. The third major lockdown by France to fight the pandemic reflects the potential for a wildcard in balancing oil supply and demand. Mobility measures show some countries back at pre-pandemic activity levels. As more countries reach that point, oil exporters will feel more comfortable increasing their output. The new OPEC plan is a test.

The recent Dallas Federal Reserve survey of U.S. oil industry conditions shows more optimism about the future. Capital spending should increase slightly in 2021, but much more in 2022. The survey also shows new well profitability targets below $50 per barrel. That means we could see more drilling. OPEC will be closely watching the U.S. rig count for signals about future U.S. oil production. For the moment, improved economics are not driving a wild activity increase, suggesting oil prices should remain in the low $60s, until we see greater demand this summer.

Natural Gas:

The farther we move away from the horrific mid-February artic weather that caused the Texas power freeze-off, as well as other regional electricity blackouts, the memory of $20+ per thousand cubic feet of gas prices fades. As the gas market has settled down, traders will be watching weather, gas production and LNG exports for indications of what will move prices in the near-term. Recently, people in different parts of the nation have experienced extremely warm temperatures, only to suddenly find themselves reaching for winter coats. It’s Springtime! The result has been a volatile phase for natural gas prices.

Immediately following the polar vortex in mid-February, gas prices averaged close to $3/Mcf. Since then, they have fallen into a range slightly above $2.50/Mcf. Natural gas production continues above 90 billion cubic feet per day, albeit down from year-ago. At the same time, gas consumed in power generation and for residential heating is down. That has allowed LNG shipments to max out, as international prices have improved. These market dynamics look to be locked in for the foreseeable future as we transition to summer with increased electricity demand to handle air conditioning.

The price action suggests traders are not bullish long-term. That is not surprising given the sustainability of gas production. Last week’s first storage injection and LNG cargos maxing out, suggest supply is not a concern. Looking out, the first futures contract with a $3/Mcf price does not occur until January 2022, and then not again until January 2029! There are some intervening winter months with gas prices approach that $3/Mcf price, but the tone of the market is dull.

In other words, as far as one can reasonably look out, traders view the era of low gas prices continuing. This supply/demand complacency is somewhat surprising given the lack of oil and gas industry spending to find new gas reserves. This pricing trajectory may be signaling that markets anticipate the push for a green energy environment will depress long-term gas demand, such that we do not need higher prices to bring forth future supply. That sentiment could change, but it is dominating gas pricing now.