Oil prices are up sharply in the last couple of months following a rebound in the world economy from the Covid-19 recession. Some may see this as a sign that an undervalued industry is finally about to see a turn for the better. The question is, will the uptrend extend well into 2021, or will it quickly reverse course?
One of the analysts I follow, Athens-based oil forecaster Kosmas Megalooiconomou, expects oil prices to continue their volatile pattern in the new year but end up higher than the previous year. Applying his Seasonality Pricing Model, he sees oil prices fluctuating between $45.51 and $57.82, with a $51.95 average, up from $39.51 in 2020. That would be a 31.50% gain if it becomes reality.
Megalooikonomou's bullish forecast is consistent with the current "technical" oil market indicators, where oil is trading well above both its 50-day and 200-day moving averages.
It's also consistent with the current "fundamentals" of the oil market, which reflect a push for a tighter oil supply in the next couple of months. Last Tuesday, for example, the Kingdom of Saudi Arabia - a traditional pace-setter for OPEC - announced that it will cut its oil supplies by an additional one million barrels daily for February and March.
That could help oil prices stabilize above $50 and perhaps even push them even higher, provided two major conditions are met: 1) the global economy continues to recover from the Covid-19 related economic recession, and 2) none of the world's major oil producers, whether it be OPEC, Russia or the U.S., decides to up production.
The biggest unknown in the oil supply equation is how the highly-fragmented and financially destitute American fracking industry will respond to higher oil prices created by OPEC's cuts. Will they boost their own production, driving oil prices lower again as they seek to bring in needed income to resolve their infamously high levels of debt? Or will they hold production steady, accommodating Saudi Arabia's move to support higher oil prices?
Shipbroker and Counselor of Athens Chamber of Commerce and Industry Fanis Matsopoulos foresees American frackers aligning with the Kindgom of Sauidi Arabia (abbreviated KSA), as they need higher oil prices, too:
"It's the first time the interests of KSA and American frackers are aligned... The KSA wants oil prices higher than $80 per barrel to maintain fiscal equilibrium and simultaneously keep ARAMCO's price stable... The American frackers want prices higher than $45 per barrel in the current zero interest rate environment to be viable. Under the current situation, even ruthless global competitors (US frackers and KSA) can become allies.... the question that arises is for how long?"
Meanwhile, there's Russia, which doesn't need higher prices. "Russia can sell oil in the range of $42 to $45 per barrel and maintain revenues at a desirable level while it gains market share," explains Matsopoulos.
Simply put, the fundamentals of the oil market are shaky. Russia's ability to fight for market share while competitors must make cuts to remain profitable could undermine the fragile KSA-American frackers "alliance," turning the recent boom in oil prices into a bust.
The prospect of the recent boom in the oil market turning into a bust seems to worry OPEC's Secretary-General Mohammad Barkindo, who warned of a downside during the group's meeting early last week. "Amid the hopeful signs, the outlook for the first half of 2021 is very mixed and there are still many downside risks to juggle," he said.
Meanwhile, the U.S. Energy Information Administration (EIA) sees limited oil upside potential from the current levels due to high inventories. They expect Brent prices to average $49 per barrel in 2021, up from an expected average of $43 per barrel in the fourth quarter of 2020.
While it's unclear which way oil prices will head by the end of 2021, one thing is clear: volatility in the oil market will continue, as demand and supply conditions can change dramatically at any time.
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