As I mentioned in my Blue Skies Ahead for Crude Oil? – Guttman Energy blog post on December 22nd, WTI was trading around $71.80//barrel, above its $71.38/barrel moving average. If it settled above that level for a few days, we thought that the temporary lows were put in and we were on the way higher towards $78/barrel. Since then, we have rallied and today WTI is trading at $80.99/barrel. The chart below looks extremely strong, but what should customers do now?
After a monster rally from $71.80/barrel to $80.99/barrel, it looks like the bulls are still in charge and will want to take this market to $84/barrel. This equates to around $0.075/gallon upside from a refined product perspective. This very well may happen due to a multitude of factors.
First, from a demand perspective, it looks like New York City may have passed its peak in the Omicron variant surge. If that is the case, it may signal that other large cities may starting hitting or have already hit their peak in Covid-19 cases which would be bullish for oil demand later on this year. Remember, a lot of institutions in the fall and early winter of 2021 were calling for oil to trade closer to $100/barrel in 2022. Those targets are starting to be talked about again, especially in an inflationary environment where commodities tend to get bid up.
Speaking of inflation, that leads us to our second factor that could continue a further rally in prices: rising interest rates in an inflationary environment. Tomorrow morning, we get insight to December’s Consumer Price Index (CPI). This is a measure of a basket of a consumer’s typical purchases which compares how much prices have risen or fallen compared to the previous month or from 12 months ago. November’s report showed that inflation grew at the quickest level since the 1980s. Tomorrow’s report is not expected to be that high, the cost of goods is still extremely high compared to normal. A way to combat that is for the Federal Reserve to increase interest rates. Market participants are forecasting that the Federal Reserve may raise interest rates 3-4 times this year. How does this impact oil prices? Commodity prices, i.e., oil is seen as hedges against inflation because it signals that there is growth in an economy. What do you need for growth in an economy? Energy! Subsequently, if investors are going to purchase energy-related assets as a hedge against inflation and rising interest rates, they’re going to either directly or indirectly purchase crude oil.
Lastly, OPEC+ oil production has been trending below their target as some nations are not producing what they agreed to. Additionally, there is a risk premium built into markets as concern persists that Russia may invade Ukraine to envelop them back into an original Soviet Union territory. An invasion would prompt the U.S. and its allies to instill sanctions on Russia, reducing its ability to produce and sell oil which would be bullish for oil prices.
The wild card right now is U.S. production. Strategists believe the U.S. will start ramping up production beyond 11.8 million barrels per day, but aren’t sure exactly how much and how quickly. With the futures curve 12 months from now getting closer to averaging $80/barrel and knowledge that many oil producers breakeven in the $50/barrel range, it might look very tempting to raise production later this year which may cap the rally in oil prices.
Until we start seeing some additional oil supply come on to the market, the bulls look to be in charge and may take this market to $84/barrel.