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Led mainly by Iranian tensions, anxiety about the Eurozone, and record-high US oil inventories, the crude market has seen more than its fair share of price volatility in the recent past.
While there are multiple reasons for these price shifts, three fundamental issues seem to be driving market sentiment: Iranian tensions, European economic concern, and record US inventories.
Iranian tensions
Earlier this year, the European Union’s decision to implement Iranian oil sanctions resulted in substantial crude price reactions. Prices for West Texas Index (WTI), a grade of crude used as a benchmark in oil pricing, peaked well above $100 per barrel, and fears that Iran might cut supplies to global markets by blocking off the Strait of Hormuz helped propel the price of a barrel of Brent crude, sourced from the North Sea, to over $128.
Iran sparked a substantial price increase earlier this year as it sparred with the western world over its nuclear program. When it held military exercises in the Gulf, oil prices surged, while fears of a prolonged conflict – and what that might do to global supplies – eventually drove WTI oil to $110 per barrel. Fast forward five months and the market is currently focused less on Iran and more on global economics.
“Iran is still trash talking, but what’s even more frightening is the bigger picture,” said Tom Kloza, chief oil analyst at Oil Price Information Service. “The economy just hasn’t looked good. There’s a sense that this malaise will march on.”
Over the past few months, market sentiment has undergone a dramatic transformation, with a glut-like scenario very much in the cards. For the quarter, spot Brent and US oil futures fell 20.4 percent and 17.5 percent respectively – their steepest quarterly percentage drop since the 2008 financial crisis.
European concerns
Adding to these issues are macroeconomic concerns exuding from Europe. While the recently signed Euro Accord does not necessarily change what is causing the financial crisis, it has notably affected oil pricing. Slowing European demand, coupled with parts of Europe being in recession, has meant that less oil is being consumed, which in turn has caused price falls.
Meanwhile, a strike by oil workers in Norway, the largest oil exporter in Western Europe, has helped support prices over the past few weeks.
“There really is very little comfort out there for any bulls that remain in the market,” said energy consultancy KBC. “The economic outlook remains bleak, oil demand growth is faltering … and crude supply is high despite the ongoing strike in Norway and the loss of Iranian exports.”
Brimming inventories
Brimming US inventories have also caused prices to stumble. Inventory levels are at their highest levels in 22 years even though the domestic refinery rate has increased from 85 percent in January to 92 percent in July, according to the US Energy Information Administration. From an investor standpoint, too much unsold product is never a good thing.
In the short term, trends are pointing to an overstocked market; however, inventory buildup can be traced back to the mid-2000s when a combination of high prices and new technology – fracking and horizontal drilling – began triggering structural changes to crude supply and demand. Add to these changes the expansion in North America’s productive oil capacity (using unconventional processes such as oil sands), and a renaissance in oil output can be noted.
The crude market is a shadow of its former self, and without a miraculous economic recovery or sudden supply shock, the benchmark price of a barrel of WTI is likely to reach a new range of $70 to $90 per barrel. From an investment standpoint there is still ample upside to the range, but if prices continue to dip some oil juniors may very well find themselves in the uncharted territory of being supply rich, yet cash poor.
Company news
TAG Oil (TSX:TAO), a Canada-based production and exploration company focused on operations in New Zealand, reported its operating highlights for the year ending March 31, 2012.
Results include an increase in proved and probable reserves to 6.624 million barrels of oil equivalent (boe) compared to 1.68 million boe a year ago (82 percent oil). Production revenue increased to $43 million from $13 million for 2011, and net income was $18.92 million compared to $1.29 million for 2011.
This reserve assessment was confined to shallow formations and does not include the higher-impact, deep liquids-rich gas prospects that TAG plans to drill within the next year.
Suroco Energy (TSXV:SRN) announced that the Cohembi-4 appraisal well in Colombia encountered 18 feet of very high-quality oil pay approximately 1.2 kilometers northwest of the closest producing well.
Open hole logs indicate 18 feet of oil pay in the Villeta N sand (true vertical thickness) and porosities that are equal to the best encountered in the Cohembi Field so far. As with all the previously drilled wells in the oil field, no oil-water contact was encountered within the reservoir sand.
The remainder of the company’s 2012 program will focus on delineating the southern extent of the field from the existing Cohembi-2 pad and the planned Cohembi-6 multi-well surface pad. Preparations are complete to facilitate two new locations at Cohembi-2, and the Cohembi-6 lease is expected to be completed in September.
Securities Disclosure: I, Adam Currie, hold no direct investment interest in any company mentioned in this article.