The euphoria that greeted the production cut agreement announcement lifted oil prices above $50 a barrel, a critical threshold for market confidence. As global oil inventories failed to drop as the market expected, investors turned on the commodity as well as energy stocks, sending their prices lower. Since the oil price drop in early 2007, prices have largely traded between the low $40s a barrel to now above $54, with a brief excursion as low as $26. The narrow price range reflected global oil inventories remaining relatively flat, until recently. As oil inventories started falling a few weeks ago, we are now in a period favorable for higher prices.
Today, we are firmly planted in an oil market reflecting positive price momentum. Better projected oil demand growth seemed to be the initial factor that helped lift the oil market. The International Energy Agency (IEA) upped its demand growth estimates for the second half of 2017. About the same time, U.S. shale producers began shedding oil drilling rigs in response to weakening oil prices and as they sensed a need to rebuild investor confidence in their financial health. Producers had to dispel the image of exploration and production (E&P) companies as destroyers of capital, a label the industry’s record seemed to warrant. Disciplined capital spending, meaning living within a company’s cash flow in order to not have to borrow money or sell more equity to fund the overspending, appears to be the new mantra for E&P companies. The latest survey of E&P company spending plans versus cash flow demonstrates that overspending remains high. This may signal that it will take time for companies to generate positive cash flow.
In recent weeks, as Brent oil prices have risen at a faster rate than WTI oil, the forward oil price curve moved into backwardation, meaning that barrels of oil able to be delivered immediately are worth more than if they are stored and delivered in the future. This price disparity is further impacted by the cost of storing the oil. Backwardation encourages holders of oil in storage to begin selling those barrels, which has accelerated the shrinking of global oil inventories.
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