Oil prices have climbed by about 50 percent from their February lows, topping $40 per barrel. But the rally could be reaching its limits, at least temporarily, as persistent oversupply and the prospect of new shale production caps any potential price increase.
U.S. oil production has steadily lost ground over the past two quarters, with production falling more than a half million barrels per day since hitting a peak at nearly 9.7 million barrels per day (mb/d) in April 2015. American oil companies have gutted their budgets and have put off drilling plans, with many projecting absolute declines in 2016.
That has sparked a renewed sense of optimism among oil traders. Moreover, supply outages in places like Iraq and Nigeria have also knocked at least a quarter of a million barrels per day offline, an unexpected disruption that put upward pressure on prices in March. Geopolitical unrest still has the ability to influence prices, even while the world is awash in oil. More oil bulls are piling on in anticipation of the April OPEC meeting, on an unfounded belief that the production freeze may actually have any material impact on global oil supplies.
But while oil traders have found some reasons to believe that oil prices are rising, there are just as many, if not more, data points to backup bearish sentiment. Storage levels in the U.S. continue to set records, hitting 523 million barrels for the week ending on March 11. Until inventories start to deplete in a significant way, oil prices will face a lot of resistance trying to break above $40 per barrel. Iran also continues to add production, albeit at a slower-than-expected rate.
In fact, the rally to $40 was largely driven by speculation. As short bets peaked and started to unwind, traders closed out positions at a rapid clip, helping to push prices up by $12 to $13 per barrel in less than two months. The trend continued last week as hedge funds and other major money managers increased their net-long positions on crude by another 17 percent. Short positions are now at their lowest levels since last June.
