US Production Gives Crude Oil Bears The Edge

US Production Gives Crude Oil Bears The Edge

The U.S. oil shale revolution may have put the brakes on rising crude oil prices.

Heading into late January, Nymex March crude oil futures were trading about $92 per barrel. Looking out later in 2014, energy analysts estimate that crude oil prices may actually be lower, rather than higher, in part due to rising oil production here in the U.S.

The oil shale revolution has changed the supply side dynamics of the U.S. crude oil market—as the U.S. now produces more than eight million barrels of crude oil per day, and that is only expected to increase in 2015.

“We are the third largest crude oil producer on the planet,” said Tim Evans, energy futures specialist at Citi Futures.  Russia stands in first place as the world’s largest crude oil producer, with Saudi Arabia in second.

Meanwhile U.S. demand has actually dropped amid an increase in energy efficient automobiles sold in the U.S. and a soft labor market.  Is cheaper crude oil the new normal? The latest figures show gasoline prices coming in at lower levels. “The national average for 2013 came to $3.491 gallon. This is 13.5 cents a gallon lower than 2012’s national average of $3.626 gallon,” according to GasBuddy.com.

What’s ahead for crude oil prices this year? “Prices may soften in 2014, particularly in the second quarter when global seasonal demand is weakest.  As a general idea, West Texas Intermediate at roughly $88 and Brent in the $95-100 range are possible averages, but we’d allow for volatility around those numbers,” said Citi’s Evans.

Chief oil analyst at GasBuddy.com Tom Kloza weighed on. “If you asked people in the next few months would crude oil have a $100 handle or an $80 handle, a lot of folks might say we will go into the $80s,” he said.

A steady stream of U.S. crude oil production is a key factor in the changing dynamics of the market. “One of the most reliable background trends is going to be a further increase in U.S. crude oil production. As of January 3, the four-week average stood at 8.109 million barrels per day,” Citi’s Evans noted. “That is the highest level since 1989 and is a year-over-year increase of 16.5%.”

In the world of crude oil, however, traders always remain on guard for geo-political risks that could pose supply disruption threats to the market. “Geopolitical risks remain the most significant ‘known unknown’ for oil prices.  We could see downside swings on a recovery in Libyan oil production, rising Iraqi production, or an easing of Iranian sanctions, but there are upside risks as well, if instability leads to a drop in supply instead,” said Evans.

A key factor to monitor this year is the impact of rising U.S. oil production on the demand for OPEC oil. As the U.S. pumps more and more crude, it ultimately needs to import less from overseas producers. “It is easy to project that U.S. production will be higher in 2014 than in 2013, which means that globally OPEC will be losing market share,” added Evans.

There’s many wild cards on the supply side, with one being the level of Libyan oil production. During the Gadhafi era, Libya produced about 1.6 million barrels per day. But, then during the civil war in 2011 that plunged to about zero. There was a rebound in early 2013 to about 1.4 million bpd, but more recently strikes and protests have pushed production down to the 592,000 bpd, according to the Libyan National Oil Corporation.

Why does this matter? “Libyan oil production is all over the place. If it stays low, other OPEC producers are not under as much pressure to limit their output. But, if Libyan output returns to 1.4 mpbd the decline in demand for OPEC crude oil becomes crucial—because OPEC producers would be under pressure to trim production,” Evans explained.

In addition to the Libyan production wild card, Iran and Iraq also offer up uncertainties on the production front in 2014. While the current Iranian nuclear agreement doesn’t include an easing on the oil embargo, “it may set the stage to restart oil exports. That is why the Iranians are at the table. They want to restart oil exports. Will they be successful? We don’t know,” said Evans.

Iran is currently producing around 2.8 mbpd and are consuming 1.8-2 mb of that capacity. Prior production however stood around 3.6 mpbd Evans noted. “If Iran produces more, the rest of OPEC has to produce less.”

Despite the uncertainties in the Middle East, the rising U.S. production trend does change the structural picture for oil traders and provide a type of “cushion” for the U.S. energy picture.

GasBuddy’s Kloza concluded: “For 30 something years, the major concern in the marketplace among traders has been uncertainty about supply. Now, in North America, the biggest uncertainty is about demand.”

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