Oil prices continued their rally this week, after an 8% surge on Friday 30 January.
As some traders try to identify the bottom in oil prices, Morgan Stanley warns that “small crude oil rallies can occur, but are likely limited and unsustainable.”
Data from Baker Hughes last week showed that US oil rigs posted a weekly decline that was the most since the drilling company started collecting the data.
In a note to clients, Adam Longson wrote that even though the headline count was an impressive decline, less rigs does not mean less production. And steady production will likely keep prices under pressure.
Overall, Longson outlined four reasons why the rally will be short-lived, and why oil prices are still going lower:
1. Investors are too excited about the rig count decline and are misinterpreting what it actually means. If I were an oil producer I’d be getting rid of the least-productive rigs- or at least moth-balling them until prices rise- and the best performing ones will probably keep working for a while because Oil companies desperately need the cash flow to pay off loans and to keep their companies running.
2. March will be a turning point for oil fundamentals. Morgan Stanley notes that there’s already more bad data for oil indicating potential for reduced long term demand. While the market largely focused on and reacted to the rig counts end-January, a Reuters survey showed that OPEC actually increased production in January. As with the Oil Production companies, OPEC nations continue to need to pump oil to generate cash for running their countries, unless they want to start digging into long-term reserves. OPEC’s refusal to cut production amid booming US shale oil has been a major contributor to the slump in oil prices. Also end-January, we also got worse-than-expected GDP data for Q4 out of the US.
3. Any rally now is a bearish signal for the second half of the year and the medium term. Energy companies have been reducing their capex as oil prices fell, and this has balanced the market. An increase in oil prices will cause more imbalance. A former BP CEO had highlighted that low oil prices force oil producers to use their resources more efficiently.
4. Because spot prices are currently higher than futures prices, any oil price rally will prompt producers to hedge (i.e., sell). This will delay any potential cuts to US production. Morgan Stanley forecasts that the price of Brent crude will fall to as low as $57 per barrel in Q1 and $43 in Q2 this year.
So, the future- maybe confused, with the occasional shock coming through, but overall not so good for Oil and not so good for local economies associated with oil and resources in general.