The oil bear market is well and truly over

Oil well in Russia © Getty Images
Russia has a greed to cut production

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And now on with today’s story…

The oil price has rocketed this morning.

Saudi Arabia, the leader of the Opec oil cartel, has shaken hands with Russia – effective leader of the non-Opec nations outside the US – to agree to reduce the global supply of oil next year.

Combined with hopes of stronger growth across the world for 2017, the deal has sent the price of Brent crude back as high as $57 a barrel this morning.

The oil bull is back. The question now is: what does this mean for the rest of us?

Don’t be surprised to see extravagant claims for oil prices in the coming months

This weekend, non-Opec oil producers – led by Russia – have agreed to reduce global supply by just over 550,000 barrels a day. Russia will be responsible for just over half of that.

The deal follows on from an agreement earlier this month between Opec members to cut production.

The oil price is now back up to where it was in the middle of 2015. And it seems likely to carry on higher (allowing for the almost inevitable backsliding after a huge leap like today’s).

In total, the theoretical reduction in oil production will now be nearly 1.8 million barrels a day. Goldman Sachs reckons that if even one million is cut, then oil prices will average more than $55 a barrel during the first half of next year.

Clearly, as the investment bank puts it, “greater compliance to the announced cuts is therefore an upside risk to our forecast”, (in other words, if Opec and non-Opec producers actually stick to the numbers instead of just talking a big game, then the oil price is likely to be higher).

This cut means that oil supply and demand are likely to come back into balance sooner than previously thought, hence the leap in prices.

But the thing is, this isn’t just a supply-side story. If the US does have a big stimulus injection, then growth is likely to pick up. And if China decides that it needs to “stimulate” its economy too (which seems likely, given the current leader’s control-freak tendencies), then that’ll drive demand for oil higher too.

So you’ve finally got a cap on supplies, just as demand looks like it’s set to pick up. Meanwhile, you’ve got market sentiment that has turned from mega-bearish to merely bearish to sceptical to cautiously optimistic. It’s likely to turn bullish next and then maybe even overshoot.

You’ll get plenty of caution (and rightly so) about the ability of US shale companies to turn the taps back on. But if prices continue to remain strong over the next month or so, then don’t be surprised if you start hearing analysts talking about a return to $80 oil quite soon. Markets have short memories and nothing gets people’s optimism going like a rising price chart.

In short, this looks like a lasting rally, and I think it’s fair to say in the wake of the deal, that the oil bear market is well and truly over.

The return of shale oil

This is, of course, great news for the aforementioned US shale producers. No one tells them how much oil to produce – all they care about is the price that they can get for it. The continuing evolution of tracking technology means that the very best fields in the US are already profitable, even if oil prices were a good bit lower than they are now. At near-$60 a barrel, more and more areas will be able to come back online.

In turn, that’s good news for the oil services companies. They’d already claimed to have spotted the bottom of the market earlier this year, and it wasn’t just false optimism.

That said, having been burned – and in many cases, driven close to bankruptcy – by the falling oil price, I wouldn’t be surprised if the shale companies (and their backers) are a mite more cautious than they were before. Perhaps supply won’t increase as quickly as we might have once expected.

On the flip side, this is not brilliant news for the likes of you and me. Oil is priced in dollars. The dollar is strong (although, to be fair, most of the damage versus sterling seems to have been done already this year). So if the oil price is going up too, then we can expect the cost of filling up our cars to go up too.

This has some serious implications for headline inflation figures. It’s going to become steadily harder for central banks around the world to use falling energy prices as cover for keeping interest rates low.

As for just how tricky that’s going to be – well, we’ll find that out later this week, when the US Federal Reserve gives us a view on what happens next with US interest rates. A small rise is almost guaranteed. What the market really cares about is how many more rises Janet Yellen expects to do over 2017.

More on that later this week – but in the meantime, if you’re an owner of the various oil stocks that we suggested you buy last year (I admit it, we were a bit early), then I’d keep hanging onto them. Higher oil prices mean dividends are more likely to be paid, which is the main thing that’s been hanging over the UK majors – so at least that’s one worry that can hopefully be set aside for the time being.

PS Remember – you can outwit the motivationally-challenged you of 31 January, simply by subscribing to MoneyWeek magazine right now. Just click here.

  • FRED

    Indeed ! Some tips : Total (TOT), Enterprise Products Partners (EPD) and Vallourec (VK) to benefit from oil price, transportation and drilling in conventional and shale oil