If oil prices have hit bottom, the top may not be too far away

The top of the oil market may be closer than you think.

With Brent futures having bounced back to US$40 a barrel, the International Energy Agency sees "light at the end of the tunnel", and Goldman Sachs Group Inc is spotting "green shoots". Even so, many analysts warn that, like the failed rally last year, this recovery will sputter once prices go high enough to keep US crude flowing.

"If prices keep going up, US production from shale producers is extremely responsive," Jamie Webster, vice president of crude markets at IHS Energy, said in a Bloomberg Television interview. "Falling US production is the key dynamic you need to get supply to equal demand, and that might not actually happen," meaning prices could fall again.

Brent futures have recovered about 40 per cent from the 12-year low of US$27.10 reached in January. With output outside the Organization of Petroleum Exporting Countries set for its biggest slump since 1992, "prices might have bottomed out," according to the IEA. Yet world crude benchmarks may struggle to push past US$50 a barrel this year as any further price recovery only delays the production cuts needed to balance the market, according to the median of a Bloomberg survey of nine analysts.

While US crude production has retreated 5.5 per cent since last summer, the process of depleting bloated inventories is just getting started, according to Goldman Sachs. The bank, which foresaw oil's plunge into the US$20s, predicts prices still need to stay low enough to starve producers of capital, otherwise the output losses necessary to remove the supply surplus won't happen.

"An early rally in prices before a deficit materialises would prove self-defeating," Jeffrey Currie, head of commodities research at Goldman Sachs in New York, said in a report on March 11.

The recovery "could throw a lifeline to US producers" that would "limit oil production declines," said Giovanni Staunovo, an analyst at UBS Group AG in Zurich.

The argument that US$50 represents a ceiling for crude is flawed, according to Sanford C Bernstein & Co, which sees prices returning to US$70 in the next year. The industry can't stay profitable at current price levels, having lost US$3 for each barrel produced last year even as companies squeezed costs, it said.

"The price of oil has to rise to balance the market in the medium run, and the medium run might be sooner than people think," analysts including Bob Brackett in New York said in a report.

The rally could in any case sputter out before it even reaches the point that revives US production, according to UBS's Mr Staunovo. Temporary price support from pipeline disruptions in Iraq will fade, while talks between Opec and non-members on freezing supply while have little impact, he said. Iran still insists it won't accept any freeze until it restores about 1 million barrels of exports now that sanctions have been lifted, Russian Energy Minister Alexander Novak said Monday following a meeting in Tehran.

This year's price trend is nonetheless similar to last year, IHS's Mr Webster said. West Texas Intermediate crude climbed 40 per cent from late March 2015 as US drilling plummeted, yet stalled near US$61 that summer as the nation's production kept going. The US benchmark ultimately sank near $40 again by August.

The resilience of US production has taken Opec by surprise, Secretary-General Abdalla El-Badri said last month. Break-even prices at North American shale wells declined by 40 per cent between 2013 and 2015, according to consultant Rystad Energy AS. Crude output remains near 9 million barrels a day even as data from Baker Hughes Inc. shows drillers are using the fewest rigs since 2009.

The reduction in costs makes Opec's forecast for a 700,000 barrel-a-day contraction in non-Opec output this year "more uncertain", the group said in its monthly oil-market report Monday.

As a result of efficiency gains, the "shale band" - the price range that allows output to be profitable - has fallen by about US$10 since last year to US$45-$55 a barrel, said Olivier Jakob, managing director at consultant Petromatrix GmbH, who originated the term. This year's rally has already buoyed US drillers, who raised US$10 billion of extra funds on Wall Street.

There's a cache of suspended wells stretching from south Texas to the Rocky Mountains that can be completed as soon as prices rise high enough, according to analysts at Bloomberg Intelligence. This reserve is known as the "fracklog," in reference to the technique of hydraulic fracturing, or fracking, used by the shale industry.

"There's a cap that has to do with when the high-cost frackers will come back in, at say US$50," Catherine Mann, chief economist at the Organisation of Economic Cooperation and Development, said in a Bloomberg Television interview. "You've got frackers out there whose capacity to come into the market is very, very flexible. So there's a range now."

BLOOMBERG