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Is $50 a Barrel the Next Stop for Rallying Crude Prices?

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At around $45 per barrel, WTI oil prices are at multi-month highs. It appears that the commodity is finally on the mend with the Energy Select Sector SPDR — an assortment of the largest U.S. energy companies — up almost 30% over the past month to be at the top of the S&P sector standings.

While the newfound momentum has taken crude to levels last seen in March, the markets remain tense over certain factors that could lead to a near-term sell-off. Nevertheless, there are reasons to be slightly bullish on oil.

Oil Rockets to 8-Month Highs

U.S. crude prices are back on the rise, benefiting from the optimism over a string of positive coronavirus vaccine development news and other factors.

The commodity has been riding high after positive trial results from experimental candidates developed by Pfizer-BioNTech, Moderna and Oxford-AstraZeneca (AZN - Free Report) . All of them have demonstrated encouraging efficacy in preventing infections without any serious safety issue, based on provisional data analyses. In fact, Pfizer and its German partner have already filed for emergency use of its COVID-19 vaccine.

For oil in particular, the developments hold out hope of protection against the deadly pandemic that has crushed the commodity’s demand and caused a bloodbath for the energy-related stocks. A potential treatment is expected to revive economic and transport activity, leading to stronger crude demand.

Oil bulls are also supported by speculation, suggesting that the OPEC+ group of producers will keep holding back supply by 7.7 million barrels per day beyond the December-end timeline, instead of relaxing the cuts to 5.7 million barrels per day from January.

Further, oil product demand in China — the world’s second-largest energy consumer — has been gradually increasing and is now almost back to the pre-pandemic levels. In recent days, refineries in Asia have shown strong appetite for the fuel, triggering a buying spree.

Finally, the formal beginning of President-elect Joe Biden’s transition to the White House has cut into a major overhang, with more certainty on this issue welcomed by oil investors.

Energy Stocks Are Hot Again

Amid gains in crude prices, shares of oil-related companies have rallied in the past one month. As a matter of fact, the top five gainers of the S&P 500 during this period were all energy firms — Occidental Petroleum (OXY - Free Report) , Devon Energy (DVN - Free Report) , Diamondback Energy (FANG - Free Report) , Apache (APA - Free Report) and TechnipFMC (FTI - Free Report) . They have gained 80%, 74%, 71%, 69% and 59%, respectively. Meanwhile, the only energy representative in the 30-stock Dow Jones industrial average, Chevron (CVX - Free Report) — carrying a Zacks Rank of #4 (Sell) — has also risen handsomely.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Key Factors That Could Kill the Upside Momentum for Oil

Despite a significant spike from the coronavirus-induced lows in April, analysts still see plenty of downside risks to oil prices.

First and foremost, oil and product inventories remain higher than their five-year averages for this time of the year. Further, the reimposition of government measures to fight the spread of the pandemic’s second wave is expected to cause another consumption slowdown. In particular, notwithstanding the Thanksgiving-fueled temporary boost in air travel in the United States, the already dire jet fuel (a derivative of distillates) market is unlikely to rebound anytime soon.

The resumption of supply from Libya, an OPEC+ member that is exempt from production caps, has added to the oil market’s problems. The North African country recently reopened its oil industry after months of civil war-led shutdown. This means more output hitting the already oversupplied market at a time of mounting demand concerns.

Among the other issues, repeated U.S.-China flare-ups have cast a pall over the nascent oil recovery. For the record, China is the world's largest crude importer and the second-biggest oil consumer behind the United States.

Oil will also have to contend with an increase in the U.S. rig activity, with oil rig count now at its highest since the middle of May. As units looking for oil continue to trend higher, production is expected to pick up in the not-so-distant future. This will offset the output curbs elsewhere and weigh on the outlook for prices.

Conclusion

The abovementioned factors point to lingering demand weakness that complicates the path toward a sustained oil price recovery. But on the whole, hopes for an early COVID-19 vaccine seems to have outweighed the negative effects associated with the new curbs and restrictions. In other words, the vaccine-rally has the potential to push oil through the $50 mark.

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