WHERE WILL THE STRONG DOLLAR TAKE OIL PRICES

The market prices in the future, and in the future they see higher interest rates in the advanced economies, even higher ones in the U.S., and a strong dollar. A strong dollar is usually a sign that oil prices will remain weak. Where is the dollar taking crude?

Growing oil supplies in OPEC countries, increasing efficiency in U.S. crude oil production, and weaker-than-forecast margins are the key risks to oil outside of dollar strength.

The U.S. government’s recent Short Term Energy Outlook suggests that oil futures will become much flatter — meaning nearby prices won’t be all that much different that prices for, say, oil deliveries in June 2019. The dynamic of improving time spreads along the futures contracts and continued Energy Information Administration reporting of weekly crude oil drawdowns might support market sentiment, even in a strong dollar world.

Barclays estimated on Monday that commercial crude stock build for this year was about 11 million barrels, lower than the 104 million barrels in 2015. In 2016 demand growth outpaced supply growth as the U.S. cut back drastically on production. EIA’s latest Short Term Energy Outlook expects domestic commercial crude stocks to be drawn down by almost 30 million barrels next year, which is supportive for oil and provides a decent argument for oil company stocks that are getting beat up by the strong dollar. Most of these draws are expected to come during the peak summer demand however.

Kuwaitis attend an electoral campaign meeting for Kuwaiti Islamist and former MP candidate Adel al-Damkhi, in Kuwait City on November 12, 2016 ahead of the upcoming parliamentary election.   (Photo by YASSER AL-ZAYYAT/AFP/Getty Images)

Higher average crude oil prices and relatively similar pricing throughout the futures market this year were good examples of improvements in U.S. supply and demand. But…say Barclays analysts led by Michael Cohen in New York, “Recent moves have come largely because of the seasonal weakness in crude oil demand.”

Fishy?

This is winter time now. Demand for heating oil is on the rise. Holiday season means demand for jet fuel and gasoline should be on the rise. The market is clearly looking further out, and see a strong dollar pulling the rug out regardless of the supply-demand equation.

OPEC supplies could be lower than expected next year if the organization members are successful in agreeing upon and implementing an overall production target. Even a 200-300,000 per day reduction for next year would go a long way in accelerating the rebalancing of physical markets. If the EIA’s crude balance estimate for 2017 is off by more than a 175,000 barrels, investors might not see backwardation — where spot prices are actually more expensive than futures. That’s one scenario. The other scenario is where production disappoints, and then investors may get to see a much flatter pricing picture.

In other words, investors shouldn’t bet on an oil rally in 2017. This does not bode well for non-U.S. energy stocks.

FORBES

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