Oil prices hit the $50 mark after almost doubling from near $27 per barrel earlier this year in February. A combination of factors have been supportive. US production, one of the biggest contributors to the growth in supply in recent years, has pulled back quite a bit from the highs of production in 2015 as a lower commodity prices idled rigs at a quick pace. It is expected that US onshore production of oil will be down high-single to low-double digit percentage in 2016 from year-end 2015. Supply disruptions in Nigeria and Canada have also contributed. Meanwhile, demand growth has remained resilient despite fears of an economic slow down in the emerging markets. Plus, we are entering the seasonally strong demand period of driving season in the US kicking off this Memorial Day weekend as those of us who will be piling the families in the car for a quick trip know. In recent markets, as oil prices have gone so have the broader equity markets and this week has been no exception. All of this despite last week’s Fed minutes that suggested that the markets may be underestimating the number of interest rate increases this year which caused the US dollar to further its rally from a recent low earlier this month.
Typically, a strengthening US dollar does not coincide with rising oil prices. Already, speculation is up on all sides. A quick Google search will bring up articles with every possible forecast. Some say oil prices have hit resistance and will fall as short-cycle US production comes back or completions of drilled-but-uncompleted wells ramp up. Others say that oil prices are setting up for a serious supply squeeze as demand trends higher and decline rates on existing production kicks in while prices are not yet high enough to cause rigs to be put back to work. Either way, this bounce in oil prices and the US dollar are likely rebounds off of overly pessimistic prior views of the world. In the intermediate term, fundamentals will win out. The Fed will raise rates eventually, even if not in June, while other central banks are still easing. That is better for the US dollar. The oil markets might face a short-term squeeze; it is a boom-bust market prone to over-reaction on both sides of the cycle. But, as we have said in prior weekly updates, the dynamic of short-cycle US production which reacts more quickly to prices means that supply change can be more timely and potentially more influential in global markets as the Saudis’ attention turns away from OPEC at the margin and towards their ambitious economic reforms. A market-driven price setting mechanism might cause better stability relative to the OPEC cartel method in the commodity price longer term