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The Crude Oil Market Is a Double-Edged Sword

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Higher crude oil prices

The recent crude oil rally is the longest weekly increase in the crude oil market since 1983. Crude oil prices have increased for nine weeks in a row. What’s the danger of rising oil prices? The US rig count is down almost 57% from last year’s levels. Baker Hughes (BHI) reported that the number of oil rigs in operation dropped by 11 to 668 for the week ending May 8, 2015. BHI will release the rig count data again today.

Oil prices continue to rally and have gained more than 3% this week. If oil prices stabilize around $65 per barrel, then US upstream players like EOG Resources (EOG) and Pioneer Natural Resources (PXD) will resume drilling activity. What happens then?

The recent rally is supported by slowing US output and declining inventories. Higher oil prices mean oil companies will resume production. As a result, the US will see a rise in oil production. This means US production will start increasing by the end of 2015 or early 2016.

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In the current oil market situation, there’s a crude oil surplus of 1.5 MMbbls (million barrels). The IEA (International Energy Agency) projects a surplus of 3.2 MMbpd (million barrels per day) in April 2015 compared to previous years. OPEC (Organization of the Petroleum Exporting Countries) crude oil production from Russia, Brazil, China, Vietnam, and Malaysia will continue to rise in 2015. This means the oil glut isn’t over.

US inventory

On May 13, the EIA (U.S. Energy Information Administration) reported that the weekly stockpile dropped by 2.2 MMbbls to 484.8 MMbbls for the week ending May 8, 2015. Inventories were at 487 MMbbls the previous week. These stockpiles are at their highest levels since 1930.

Another rise in production means a fall in oil prices is inevitable. The only possible remedy for the crude oil market is for demand to pick up. Otherwise oil prices will fluctuate broadly. Chinese demand is slowing down, but imports are increasing. Lower oil prices could spike short-term demand. The near-term benefit of more production means more market share. There’s no real catalyst for a massive demand spike.

Oil and gas ETFs such as the Energy Select Sector SPDR Fund (XLE) and the SPDR Oil and Gas ETF (XOP) fell in yesterday’s trading, following the direction of crude oil prices.

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