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U.S. Crude Nearing $70 a Barrel: Is the Oil Crisis Over?

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Following renewed geopolitical tensions in the Middle East and reports of strong OPEC compliance with the supply pact, the front month West Texas Intermediate (WTI) crude futures edged up 0.4% (or 25 cents) to end at $67.07 per barrel yesterday – the highest settlement since December 2014.

Why Are Prices Soaring?

The surge in benchmark crude is being driven by mounting tensions in the Middle East and the resultant fears of supplies being disrupted. The commodity literally took off this week after President Trump hinted at the possibility of a military strike against Syria and Saudi Arabia claimed to have intercepted missiles fired by Yemeni rebels.

As it is, crude is being well supported by a variety of catalysts, including strong demand and continued production curbs from OPEC and its allies.

Red-Hot Demand: The major factor fueling higher oil prices is the fast-growing demand for the commodity, which continues to tighten the market. Recently, the International Energy Agency (IEA) reaffirmed its crude demand estimates. The energy consultative body, in its closely watched monthly oil-market report, said that global demand is likely to grow by 1.5 million barrels a day this year to average 99.3 million barrels a day.

OPEC Supply Cuts: One of the significant reasons why the U.S. oil benchmark soared nearly 17% in the previous quarter revolved around expectations that OPEC and other major producers’ agreement to expand their output-cut deal beyond March. The coalition prolonged the current dynamic for another nine months to the end of 2018. The agreement, now renewed twice, keeps 1.8 million barrels a day (or 2% of global supply) off the market in an attempt to clear a supply glut.

Sharp Inventory Drawdowns: The U.S. Energy Department's inventory releases have shown multiple weeks of strong inventory draws in the domestic crude stockpiles, another pointer to a tightening oil market. Oil stockpiles have actually shrunk in 37 of the last 53 weeks and are down nearly 105 million barrels in the past year.

The gradual fall has helped the U.S. crude market shift from year-over-year storage surplus to a deficit. At 428.6 million barrels, current crude supplies are 20% below the year-ago period and are in the bottom half of the average range during this time of the year.

The Venezuela Factor: Fast falling production in Venezuela have added to the jitters. With the country tethering on the verge of an economic collapse, oil output has dwindled by almost 50% since 2005. Venezuela currently churns out less than 2 million barrels per day, much lower that its pledge per the OPEC-led supply cuts.

Are the Gains Built to Last?

The oil market, notwithstanding its recent rise, could be undermined by soaring U.S. production. Volume from U.S. oil fields (inclusive of shale) has risen 25% since mid-2016 to more than 10.5 million barrels per day – the most since the EIA started maintaining weekly data in 1983. In early February, oil production broke through the 10 million barrels a day threshold for the first time in nearly 50 years and has maintained the record levels thereafter.

While there is renewed optimism among U.S. oil companies amid the $65-plus WTI prices, crude’s recent gains could become self-defeating as elevated realizations have already induced producers – especially U.S. shale drillers – to ramp up activity. Together with the scheduled conclusion of OPEC/non-OPEC production cuts in December this year and we are looking at another selloff in oil prices.

A rise in the oil drilling rig count points to a further increase in domestic output. An early gauge of future activity, rigs drilling for oil in America totaled 1,003 in the week to Apr 6, as per the latest weekly report by Baker Hughes, a GE Company. That's much higher than the year-ago tally of 839, indicating a drilling resurgence in tandem with the oil revival – a big concern for investors.

To sum up, even as crude prices make their way up, the relentless supply growth out of U.S. continues to undermine output curbs by OPEC and non-OPEC members, posing a risk to the fragile oil market.

Moreover, announcements of duties and counter duties by Washington and Beijing on a wide range of imports have led to apprehensions of a full-blown trade battle between the world’s two biggest economies. Market participants fear that the dispute could potentially hamper global growth and harm oil demand.

What’s Ahead?

While we do not rule out chances for short-term pullbacks on oversupply concerns, we remain extremely confident of an extended period of gains in the near future.

An anticipated surge in demand this year is set to push global consumption above 100 million barrels per day threshold for the first time. However, supply from OPEC – which still accounts for roughly 40% of the world's crude – is expected to remain weak throughout 2018. The cartel’s strong adherence with the production cut pact (now at 163% of target levels) has meant that worldwide supplies, currently at around 98 million barrels a day, are lower than demand.

Also, years of low price environment have forced operators to trim their capital expenditures considerably that means a relatively narrow pipeline of new projects.

To sum it up, though the triple-digit territory of 2014 looks improbable, we expect oil prices to continue to head higher. Also, we are confident that improving fundamentals have probably put a floor under crude prices for the time being.

Meanwhile, Go for Select Energy Names

The integrated players have reaped benefits of cost-containment strategies adopted during the historic downturn period. They focused on realigning their business models to a more lean and efficient structure so as to stay competitive in the long run. They engaged in reducing headcount, streamlining operations, divesting non-core projects, slashing capex and operating costs to bolster their financials.

Riding on the positive oil price momentum, the major oil firms like Chevron CVX, BP plc BP, Royal Dutch Shell plc RDS.A and Total S.A. TOT – all part of the ‘Big Oil’ group – recorded massive year-over-year growth in their fourth-quarter top and bottom line, with expectations that the trend will continue during the upcoming earnings season as well.

While all crude-focused stocks stand to gain from the oil rally, companies in the exploration and production (E&P) sector are the best placed, as they will be able to extract more value for their products. We advocate the likes of Continental Resources Inc. CLR – a Zacks Rank #1 (Strong Buy) – and Murphy Oil Corp. MUR.

Finally, a rise in the Baker Hughes rotary rig count positively weighs on the demand for energy services – drilling, completion, production, etc. At this juncture, adding a few of these stocks to your portfolio might as well make for a prudent option. Mammoth Energy Services, Inc. TUSK and Flotek Industries, Inc. (FTK - Free Report) , both carrying Zacks Rank #2 (Buy), may be excellent selections.

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