Greetings:

The next month or two figure to be an extremely bumpy period for the oil market. Predicting what the price of crude will do any given day will be even harder than usual. The only thing you can count on is plenty of volatility. Traders are digesting worries about real or potential shutdowns of oil production on four continents, even as the global economy shows signs of slowing, which could dent oil demand. But when the dust clears, we suspect the price of a barrel of oil this summer won't be radically different from today's level.

Wildfires, Terror Attacks and More

Looking for an explanation of the recent rally in oil prices? Where to begin? First, there's the massive wildfire in Canada's oil-rich Alberta province, which spurred the evacuation of an entire city. No damage has been reported at the region's sprawling oil sands mining operations, but many firms slowed or shut down work as a precaution and to provide shelter for nearby residents displaced by the fires. Up to a million barrels of daily crude production is now off line.

In Nigeria, attacks by militant groups have hit pipelines and offshore oil platforms, shuttering a substantial portion of that country's daily output. Civil war in Libya has further reduced what little production had been on line during a shaky truce between two rival governing factions. In Venezuela, the cratering economy is sparking fears that the regime of President Nicolás Maduro could lose the ability to keep exports flowing. And Saudi Arabia recently muddied the picture by dismissing its long-time oil minister, Ali al-Naimi, in what some analysts saw as a sign of a policy change in the world's largest oil producer.

It all adds up to a critical question for oil markets: Is the world about to shift from oversupplied to undersupplied? After all, the price of crude started tumbling late in 2014 when OPEC announced that it wouldn't curb its production in the face of rising output from America's prolific shale fields. Stockpiles of oil held in storage soared as production outran consumption. West Texas Intermediate, the U.S. oil benchmark, plunged from about $100 per barrel in the summer of 2014 to just $26 per barrel in February 2016. Firms working in the shale oil deposits of North Dakota and Texas started going bankrupt.

Going from glut to shortfall in the span of weeks has sent oil prices spiraling higher. From that low of $26 per barrel in February, WTI has rebounded to $48, and oil bulls are betting the rally has further to run. But after such a torrid rally, it probably pays to be skeptical.

For one thing, the market still looks oversupplied. Although Canadian production took a huge hit from the Alberta fire, and U.S. output continues to dwindle as operators shut down drilling rigs, production is ramping up in other parts of the world. Iran continues to boost its exports now that Western sanctions on its oil industry have been lifted. In April, OPEC reported that its combined output rose by almost 200,000 barrels per day (despite the problems of OPEC members Libya and Nigeria). OPEC also expects Russia to boost its prodigious output by 100,000 barrels per day in 2016, compared with 2015 levels.

And global petroleum stockpiles are bulging, a legacy of the recent gap between supply and demand. The International Energy Agency reports that total stockpiles held by economically advanced countries exceeded 3 billion barrels in February, well above the average level over the last five years.

Some savvy oil market analysts aren't buying the rally, either. Stephen Schork, editor of energy investing newsletter The Schork Report, says the various trouble spots around the world are a legitimate concern for the oil market. But unless output losses turn more severe somewhere, he expects oil prices to decline fairly soon. This is "not a fundamentally sound rally," he says. What's more, "producers are selling into this rally," by which he means energy firms are rushing to lock in present crude prices in contracts to sell their future output. That's not exactly a vote of confidence from companies with the most incentive to predict where prices are going.

The shake-up in Saudi Arabia's oil ministry could also be bearish for prices. Some news reports greeted the announcement of al-Naimi's departure as a sign that the kingdom might be thinking of ditching its recent policy of keeping the oil spigots open to compete with archrival Iran. But a new oil minister doesn't necessarily signal a new oil policy. Prestige Economics President Jason Schenker, whom we interviewed recently, says al-Naimi probably retired, rather than was forced out. Schenker attends OPEC's regular meetings in Vienna, as well as private dinners with the Saudi delegation, and his read is that the kingdom will maintain its recent lofty production level to protect its share of the market as Iran boosts its exports.

So where does that leave prices? We figure that all the talk about supply disruptions will probably cause some brief but sharp price spikes in coming weeks. The approach of Memorial Day and the unofficial start of the U.S. summer driving season should also nudge prices higher. But unless some new disaster or geopolitical upheaval crimps crude flows, we look for WTI to return to a trading range of $40 to $45 per barrel by early July.

Meanwhile, drivers can expect gasoline prices to push a bit higher. According to AAA, the national average price of regular unleaded hit $2.23 per gallon yesterday, up about a dime from a month ago. The average price will probably top out somewhere between $2.30 and $2.40 late this spring before leveling off. No one likes paying more, of course. But with memories of $4 gas still fresh in the minds of many motorists, that probably won't feel too painful as folks hit the road for the beach or the mountains this summer.

Sincerely,

Jim Patterson

jpatterson@kiplinger.com

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