By: Robert Mitkowski
Oil prices have pulled back as demand has eased and supplies have increased. But volatility is par for the course in the drilling business, and the pendulum may well swing back the other way before long.
Demand for oil began the year on an up note, given the abnormally cold temperatures in North America last winter that charged up demand. Both the regional and international pricing benchmarks, West Texas Intermediate and Brent, traded above $100 a barrel early in 2014. For a time, speculation that the long-standing ban on exporting oil from the United States might be overturned provided additional support for prices.
But supplies in North America continued to build. In 2013, the amount of oil calculated by the Department of Energy to be on hand carved out a new five-year high for most months, and that has continued to be the case in 2014. Shipments from Libya, while still not completely reliable, have recovered somewhat, as well.
Moreover, economic growth in Europe began to slip as the tensions with Russia over its foray into Crimea and Ukraine took a toll on business in the region. That has reduced petroleum demand prospects somewhat, as has less-than-spectacular growth in China.
As a result of the reduced possibilities for growth abroad, the International Energy Agency, a Paris-based consulting group, recently reduced its forecast for oil demand growth to 900,000 barrels a day, down from 1.2 million barrels a day earlier in the year.
Another factor hurting oil prices is the strength of the U.S. dollar. Since oil is priced in dollars, a strong greenback goes further when it comes to filling oil requirements. In recent months, the dollar has strengthened notably against the euro, owing to Europe’s relatively poorer prospects compared with the United States.
Finally, seasonal weakness has played a role in the recent slide in oil prices, since late summer and early fall are periods when petroleum demand tends to be at its weakest. All things considered, oil prices have eased into the $90-a-barrel range, from above $100 previously in 2014.
The bad news aside, oil prices remain comparatively elevated on a historical basis, and are likely to remain so for several reasons. Those include the high likelihood of further periodic disruption of supplies from politically unstable producing countries in the Middle East and Africa. There is no getting around the fact there are a number of unstable regimes among OPEC’s 11 producing members. It is never clear when problems in one or more of them might materialize, but oil quotations seem to be carrying a permanent premium because of that uncertainty.
Also on the plus side for oil prices are the most recent set of sanctions placed on the Russian energy sector by the European Union and the United States. Those actions point to less supply growth coming out of Russia, both in the short-term and the long-run. Sanctions on Russia have caused Dow-30 component Exxon Mobil (XOM – Free Exxon Stock Report) to wind down its thrust into drilling in the Russian Arctic through a joint venture with Rosneft. That initiative, in one of the coldest and most forbidding places on earth, north of the Arctic Circle, shows the lengths oil companies have been forced to go in order to secure fresh supplies. If nothing else, such a difficult endeavor underlines the fact that oil has a significant intrinsic value, given the high cost of drilling in the Arctic.
Long-term investors and contrarians might wish to take advantage of the recent weakness in oil prices to pick up shares that have backed off in sympathy. In addition to Exxon, stocks fitting that theme include oil major Chevron (CVX – Free Chevron Stock Report), large-cap independent Anadarko (APC), and oilfield services provider Baker Hughes (BHI).
