Oil prices: A bear and a bull on the rally

The price of oil has been heading up for eight trading sessions, raising the hopes of energy companies, investors and the whole province of Alberta. But is this rally the real thing, or is the market misreading the signs? Here are two takes on the oil price rally.

The Bear 

Stephen Schork is the editor of the Schork Report, an investment newsletter that is dedicated to the energy market. Schork describes the current rally as a classic short squeeze rally. Which can be a bit tricky to explain.

All of the fundamental drivers in this market point to even lower oil prices.- Stephen Schork, The Schork Report

As the price of oil dropped through the fall and winter, many traders started to short futures contracts, essentially betting that the price will continue to go down. In the past two months, the price of oil has started to rise and some of the traders who were shorting futures contracts had to cover their short positions, by buying futures contracts, which pushes the price up higher. Clear?

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"All of the fundamental drivers in this market point to even lower oil prices," said Schork in an interview.

Schork points out that there is a lot of demand from two places right now: The first is refineries, which are making a lot of money refining crude into gasoline, diesel and other products right now and are buying as much feed stock (ie. crude oil) as they can.

"Refineries are running at 93 or 94 per cent of capacity, which is very high for this time of year, but you can only manufacture so much product before those margins shrink," he says.

Right now, demand is also being driven by the so-called storage play, in which you can buy oil cheap on the spot market, store it, and then sell it in the futures market for a better price.

"We're producing 9.3 million barrels a day, once you take the refinery out, once you take the storage operator out, you take the two biggest buyers in this market out and it's going to occur at a time when we're at maximum capacity.

"So there's not going to be a lot of places to store the oil and we in the United States can't export the oil, so that oil is going to sit there and we're just going to continue to build the glut, so that will continue to weigh on the price."

Schork expects oil will test the $40 a barrel level sometime this summer

The Bull

Chris Lafakis, a senior economist with Moody's Analytics, is quite a bit more optimistic in his outlook for oil prices.

"We have for some months now been expecting (WTI) oil prices to rise to $75 by the end of 2015," he says.

"The market is really underestimating the extent to which U.S. oil production is going to slow in the second half of 2015 because of the lack of investment as a result of the price decline especially in the shale oil patches in the United States."

We have for some months now been expecting (WTI) oil prices to rise to $75 by the end of 2015.- Chris Lafakis, Moody's Analytics

Lafakis points to the depletion rate of the U.S. shale well, which have a much shorter production life and need to be replaced with new wells.

"When you reduce active oil rigs by 50 per cent, you're not replacing the depleted wells as fast as you have in the past and that will lead U.S. oil production to decline in the second haf of 2015."

"That's the main reason why oil prices will rise, the supply side response."

There's also some debate about what gasoline demand will look like this summer in the United States. Stephen Schork feels that enough people are using clean diesel or hybrids that demand will not rise as much as expected. 

But Chris Lafakis points out the U.S. is seeing higher SUV and pickup sales, and gasoline demand was up on a year-over-year basis by around 2.5 per cent.

"Especially in the U.S., summer driving season gets going in the second and third quarters of the year. Global oil demand gets going, that will narrow the excess supply gap," said Lafakis.

"Couple that with strong growth in the global economy and the response on the supply side and that's how you get to $75 by the end of the year."