3 reasons crude oil is set for a big rally

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After rallying hard in 2016, crude oil has been range bound for much of the past year.

Front-month Brent crude futures — the global benchmark — has been up and down over that period, and in that order, trading between $44 to $58 per barrel since OPEC and non-OPEC agreed to cut global production levels back in late November last year.

After the rout and rally seen between mid-2014 and late 2016, lately it has been relatively calm.

However, the question traders are now asking is if it will last.

Is this a period of consolidation, or merely the precursor to another jarring move, either to the upside or downside?

Brent Crude Futures Weekly Chart

Economists at Capital Economics believe it’s likely to be the latter, and to the upside, forecasting Brent crude will finish the year at $60 per barrel, representing an increase of more than 20% from its current level of $48.90 per barrel.

It’s a big move, and one that will have ramifications for financial markets, particularly when it comes to the outlook for monetary policy, should Capital Economics be proven correct.

The group believes that there’s three main factors underpinning its view: global demand looks set to improve, led by the eurozone and United States; OPEC members should abide by previously announced production cut quotas; and US shale oil production, something many have cited as a key reason why the rally in crude has stalled, looks set to slow.

On the latter factor — slowing US production — it points to the chart below showing the relationship between Brent prices and the number of active drilling rigs in operation in the US.

Source: Capital Economics

Should the relationship hold true, the recent pullback in prices points to the likelihood that US production levels will slow. Capital Economics says this, along with firming demand and steady supply from OPEC members, should help to support prices.

“Taking this all into account, we still expect the price of Brent to rise to $60 per barrel by end-2017,” it says.

And, given the current balance of risks, it thinks this price target could be achieved even sooner than the end of the year.

“For example, a worsening of the crisis in Venezuela could lead to further disruption to oil production, as happened in 2003,” the group says.

“Meanwhile, Iran and Saudi Arabia are fighting proxy wars in Yemen and Syria, which show no sign of being resolved. Direct conflict between the first and third largest producers in OPEC could severely impact oil supplies.

“Finally, actions taken by US President Trump, either against Iran or North Korea, could also push up oil prices.”