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A Bullish Case for Oil with No Production Growth in Sight

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Oil prices topped off at $50 last week after the International Energy Association released its monthly oil outlook report, which consisted of an increased forecast in world oil demand. With output and inventories steadily falling, we could see a continued wave of rising oil prices .

The IEA expects a demand growth of 1.3 million barrels a day in 2017, as the United States experiences record-high gasoline consumption. The global demand for refining is also approaching record highs. On the supply side, the United States' annual production is expected to drop in both 2016 and 2017. IEA projects the United States to produce 830,000 less barrels per day than 2015 at a production of 8.60 million barrels. In 2017, oil companies are expected to restart more rig sites with higher oil prices. However, overall production will continually fall off by an estimated 410,000 barrels. The IEA adjusted its OPEC production forecast from its previous report by a decrease of 80,000 barrels per day in 2016 and 50,000 barrels per day in 2017. On the global scale, IEA's 2015 oil production estimate dropped by 30,000 barrels per day.

The figures of excess oil supply are now revised to reflect the disparities of altered demand and supply forecasts. The 2015 excess supply forecast dropped by 30,000 barrels per day and 20,000 barrels per day in 2016. Investors should be optimistic with excess supply numbers falling dramatically year to year. 2015's revised figure of 1.93 million barrels will drop to 970,000 in 2016 and to 290,000 in 2017.

The IEA's report consists of only small differences from its previous report. The slight adjustments illustrate a positive trend for investors in the oil market, as forecasts continue to lessen the existing imbalance. The report has reinforced the power of the IEA's previous estimates which leaves us with greater confidence in the organization's optimistic outlook for oil.

Oil prices have risen due to increasingly stronger demand, the weakening U.S. dollar, and supply cuts through disruptions in Canadian and Nigerian oil production combined with American oil producers electing to decrease output. We are experiencing a tremendous pullback in oil production which is rapidly eradicating the global surplus. To add, oil inventories have continued to falter over the past few months, clarifying the market's upward direction. Domestic crude oil inventories fell by 3.2 million barrels last week, surpassing the market's expectations of 2.7 million.

Tom Ward, founder of Chesapeake Energy ( CHK ), backs the claim for a bullish oil market, "Until the capital markets open up and allow U.S. oil companies to spend outside of their cash flow, production will not increase and crude prices will continue to rise...until we have something fairly dramatic happen like maybe a doubling of the rig count, I don't think we can grow production". The aforementioned oil forecasts and rapidly declining inventories coincide with Ward's logic for increased oil prices. A dramatic increase in oil production in the current climate is very unlikely.

On the other hand, seeing unusually striking drops in production is an anticipated possibility that may arise with heated political scenes and weak infrastructure in African oil producing countries and the Middle East. Nigeria is currently experiencing troubles with rebel organizations sabotaging its oil rig and pipeline sites. Weekly bombings and thefts are deteriorating the nation's supply of oil by over 500,000 barrels per day. Chevron ( CVX ) has been forced to cease large scale operations in western Africa following persistent warnings and attacks, which have led to the loss of millions of barrels per day. In Iraq, security concerns over the highly disputed Kurdistan region have recently interrupted the production of 600,000 barrels per day. Iraqi oil production plunged another 320,000 barrels per day dealing with threats from ISIS militants. Algerian oil producers have experienced massive losses in production in 2016 due to attacks by terrorist groups as well. Libya is now producing only 360,000 barrels per day following the destruction of its marine exporting hubs. This is miniscule production relative to Libya's conventional output of 1.6 million barrels per day. Libyan production will not see any major improvement as five of the nation's seven onshore loading terminals are no longer operational.

The weak infrastructure in the region is equally subtracting oil output. Just earlier this week, Royal Dutch Shell's ( RDS.A ) Trans Niger Pipeline was shut down due to a major leak and as a result, 130,000 barrels per day of production will be lost indefinitely. To make things worse for producers, oftentimes militant groups launch attacks on pipelines while repairs are being performed to further drawback efforts to revive production. In addition to Chevron and Shell, there is strong potential in seeing the exit of Conoco Phillips ( COP ), Exxon Mobil ( XOM ), Petrobas ( PBR ), and other big oil companies to avoid the backlash of infrastructural problems and terrorism. The oil market has been riding these disruptions to ascended price levels in the recent recovery and we can expect that to continue with overseas withdrawals.

Depleting supplies and a record demand of oil products are likely to act cohesively and systematically bring balance to the market. As we approach the market balance, oil prices should continue to rise. Some institutional investors are betting on oil prices recovering to its pre-crash levels of $100 and higher. The potential growth may be astronomical once inventories have diminished.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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