For the most part, 2016 was a miserable year in the oil and gas industry, as a massive oil glut fuelled by overproduction and a historically slow pace of growth in the Chinese economy conspired to drive oil prices to their lowest levels in 13 years.
After touching $26 per barrel in February, however, oil prices have gone on an extended rally, moving above $50 in July on widespread sentiment that the commodity was oversold earlier in the year. Many investors also held the notion that global economic growth would overtake production in the short-to-medium term.
Uncertainty took some wind out of the sails of this rally mid-year, though, as prices oscillated between $40-$50 as doubts crept into the minds of investors on platforms such as ETX Capital, as it was unclear for many months on whether a rumored OPEC production cut would become a reality.
However, after a few false starts, they finally came to an agreement on November 30, with the members of the trading bloc agreeing to production cuts totaling one million barrels per day.
On top of this, some of OPEC’s rivals have also agreed to shut in some of their production as well, which means as much as 1.8 million barrels of oil could potentially be taken off the market in 2017.
To be sure, this is a bold move by one of the most influential players in the oil and gas industry, but how long will this measure extend the current bull rally in the oil futures market?
It is our opinion that this will help extend gains over the coming year, but as we will reveal in the paragraphs below, 2017 will be far from smooth sailing for traders.
Expect a healthy rise in prices through the first half of 2017
Should OPEC make good on their promise to cut production significantly in 2017, the first half of the new year should see markedly higher prices, as oil reserves worldwide will begin to decline in the face of reduced supply.
Much of the early rally will be based on irrational exuberance, as tank farms such as the one in Cushing, Oklahoma will take time to empty to the point where national oil supplies could be considered to be in a constrained state.
The return of driving season should place a significant strain on oil stores, although a winter that is colder than expected could begin the draw down in reserves sooner than anticipated.
When it becomes clear that consumer demand for petroleum is exceeding the amount that is being pumped by producers, prices should be sent significantly higher.
While it is true that the United States, Canada, and other non-OPEC countries boast significant production capacity, they can’t hold a candle to the fact that OPEC pumps 40% of the world’s oil and controls 70% of the world’s proven reserves.
With Saudi Arabia and other OPEC powers intending to dramatically reduce shipments of oil to western countries such as the United States in 2017, the resulting imbalance between supply and demand will be more pronounced than in recent years.
On this basis alone, a strong case can be made for the continuation of the oil bull rally that began in early 2016.
Further gains in 2017 likely to be capped by concerns
Although OPEC’s intervention in the market will act as a catalyst for higher energy prices as we move forward into 2017, deeply entrenched economic, geopolitical, and environmental concerns will likely act as headwinds to further gains as we move deeper into the coming year.
The most significant of these is the state of the sluggish global economy. For many years, China had stoked an economic boom in commodities as it made its meteoric rise from developing country to one of the world’s most influential superpowers.
However, as its economy has begun to mature, the double-digit economic growth rates that had long been accepted as normal have begun to decline, taking the world’s economy down with it.
Although any country in the world would kill for an annual growth rate of 6.9% (China’s rate of growth in 2015), their GDP has not advanced this slowly since the Global Financial Crisis of 2008, and the Asian Financial Crisis of 1998.
A series of declines in the growth rate of China over the past five years has had a domino effect around the world, increasing supplies of oil and other minerals that it had been using at a breakneck pace in the previous decade, crippling producers.
Despite the recent actions of OPEC, medium to long-term growth in the price of oil will depend on whether the world’s biggest economic driver can get its mojo back.
Additionally, OPEC has had difficulty in the past policing its members with regards to production caps. As the price of oil begins to rise in response to their cuts, the temptation to break rank in order to engage in profit-taking will increase among members, just as it has in the past.
This is especially true for those that have had their coffers bled dry (Venezuela, Libya, Iran, etc) by two years of low energy prices. Paired together with increased production by American shale oil producers and Canadian oil sands firms, any sudden increase in supply could send prices lower just as quickly as they might rise in 2017.
Also significant is public sentiment towards climate change. As bizarre weather events have occurred with increasing regularity in recent years, consumers have begun to look for low/no-carbon alternatives for their transportation and home heating/cooling needs.
This has led to the rapid rise of wind and solar, electric cars, and effective energy storage solutions through much of the 2010’s. Although the primacy of fossil fuels will probably not be challenged for at least another decade or two, it seems likely that alternative energy will become a direct competitor of theirs within that time frame.
In the short-term, traders can expect the price of oil to increase, as OPEC’s actions will significantly curtail supply in 2017. However, investors would do well to pay close attention to the news over the next five to ten years, as factors discussed earlier in the article will at least weigh on further price increases over the medium to long-term.
Ben Barlow is a contributor for the BOE Report – The Source for oil & gas news and information