Short-term Oil Outlook: Oil Hits $50 bbl. Now what?

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West Texas Intermediate and Brent crude prices traded above $50 bbl in late May and early June if only briefly, a psychologically significant price point. The question for market followers now is what does $50 bbl, a price seen high enough for some U.S. producers to return idled rigs into service, mean for the oil market in the coming weeks.

Firstly, while crude prices have crossed above the psychological benchmark, they will need to hold above $50 bbl for a few weeks to prove crude oil prices are trending higher. Considering the amount of inventory, with U.S. commercial inventory still bloated and ending May more than 130 million bbl or 33% above the five-year average, establishing a durable uptrend will need additional support.

The recent rally to $50 bbl was supported in large part by declining crude production in the United States, which ended May at 8.735 million bpd after a steady string of weekly declines over a three-month period that dropped the domestic output rate to the lowest point since September 2014. U.S. crude production is down nearly 1.0 million bpd from its peak in April 2015.

Forecasting agencies including the Energy Information Administration, the International Energy Agency and the Organization of the Petroleum Exporting Countries have all projected that a drop in U.S. production would contribute the major part of the global rebalancing between supply and demand. Indeed, it was U.S. production that was the driver of the imbalance, with non-OPEC supply growing 1.6 million bpd in 2015, so the steady decline in U.S. output fits the outlook.

OPEC, during their June 2 meeting highlighted falling non-OPEC supply, calling for a contraction of 740,000 bpd this year that, along with global oil demand growth of 1.2 million bpd, would bring market fundamentals into closer equilibrium. This outlook was cited in the oil producer’s group’s decision to not cut their output to shore up prices, saying the global market was currently moving through the balancing process.

Previously, the IEA projected the market to rebalance later this year or early 2017. Wildfires in Canada and targeted militant attacks on oil infrastructure in Nigeria among other supply disruptions have shut-in well more than 1.5 million bpd in the second quarter that, even though short-lived, have accelerated the move toward a production-demand balance.

WTI crude prices, the U.S. benchmark, could also find support in a weaker U.S. dollar in early summer, with domestic oil and the greenback having an inverse relationship since crude oil trades internationally in the dollar. The dollar had strengthened from early May weakness on growing market sentiment that the Federal Reserve would hike the federal funds rate–the overnight borrowing rate between banks that sets the interest rate for mortgages, auto loans and credit cards–at their June 14-15 meeting. However, a dismal report on U.S. employment gains in May that was deemed “a shocker” upended that sentiment, and is seen pushing back a rate increase.

With oil production high, including increasing output from several members of OPEC including Saudi Arabia and Iran, lower non-OPEC supply could be offset even if only partly by new barrels from OPEC.

Moreover, $50 bbl crude was seen by many in the market as the price point that would turn the switch back on for some U.S. producers. This analysis is arbitrary since producers have varying production costs as do the wells they drill.

Clearly, the higher price a barrel of oil fetches will help some producers. In fact, the week following crude’s crack through the psychological barrier, oil services provider Baker Hughes, Inc. reported nine rigs drilling for oil were brought into service, the first increase since a one-rig gain in mid-March.

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