Crude oil is surging on a 'shaky foundation' and it won't end well

Earlier this week, crude oil prices jumped into a bull market.

But this latest rally is based on “shaky foundations” and will revert soon, according to Thomas Pugh, commodities economist at Capital Economics.

We were here just a few months ago.

In April, oil producers in OPEC and non-OPEC nations met to try and reach a freeze agreement on output levels, which were too high.

Ahead of the meeting, chatter from Russian officials and others that suggested the meeting would end with an agreement drove traders to buy oil futures.

The meeting ended with no deal because Saudi Arabia did not want to enter a deal without Iran.

“The recent rally in oil prices has been primarily driven by speculation about a possible deal between OPEC and major non-OPEC producers to freeze production,” Pugh wrote in a note Friday.

West Texas Intermediate crude futures gained nearly 23% through Thursday from the bottom in early August, when they fell below $40 per barrel. Brent crude, the international benchmark, rose above $50.

It wasn’t a sudden disappearance of excess inventories that sparked the current rally. Instead, it was the same thing we saw in oil markets leading up to the failed April OPEC talks.

Some pessimism is warranted about a pact to slow down production. “As a result, we think that prices will fall back over the next few months as the outcome of next month’s unofficial meeting underwhelms market expectations,” Pugh wrote.

Meanwhile in the US, oil producers have been bringing rigs back online. This week, the oil rig count rose for an eighth straight week, extending the longest gaining streak of this year.

In short, crude oil is rising on hopes of talks between OPEC that may result in a production freeze but very well may not. And the supply imbalance in the market has not been dealt with.

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