Have oil prices bottomed?

Since hitting a low of under US$30 a barrel in mid-January 2016, oil prices have recovered to trade above US$40 a barrel recently. The International Energy Agency (IEA) now says there are signs that prices may have bottomed out.

Production has fallen in both OPEC and non-OPEC oil-producing countries, while demand growth has sharply decelerated according to the IEA. The Agency says demand growth, particularly in China and the US has pulled global growth down to a one-year low of 1.2 million barrels a day.

Supply disruptions in Iran, Nigeria and the United Arab Emirates (UAE) saw production from those countries fall by 350,000 barrels a day in February – but they are likely to be temporary. The IEA also seems to think that Iran’s return to full production will be gradual.

US production is expected to fall by 530,000 barrels a day as high-cost producers continue to bear the brunt of the lower commodity price. A shale oil revolution in the US saw production almost double between 2010 and 2015 – which saw OPEC (the Organisation of Petroleum Exporting Countries) increase its production levels to maintain market share. But shale production is generally much higher cost than conventional oil production, which is leading to plenty of US oil drillers dropping out of the market.

As we showed in this article in February, shale oil production is crashing and more than 60 oil and gas producers have already filed for bankruptcy, with another 150 reported to be on their way.

That’s all good news for the likes of Santos Ltd (ASX: STO), Origin Energy Ltd (ASX: ORG), Woodside Petroleum Limited (ASX: WPL) and BHP Billiton Limited (ASX: BHP), although not as good as some had hoped.

Santos said in November 2015 that it hoped to be cash flow positive with oil prices at US$50 a barrel and the Australian dollar at US 70 cents. Unfortunately for Santos, oil is still below that target, and the Aussie dollar has soared above US 70 cents. Cash flow positive also doesn’t necessarily mean profitable.

The biggest risk is that higher cost oil producers are working frantically to slash their production costs, and the more the oil price rises, the more producers that will become profitable.

Foolish takeaway

Economics suggests oil should find an equilibrium price when supply and demand are balanced. The IEA thinks that might happen sometime in 2017 as the gap between supply and demand narrows, particularly towards the end of this year.

I’ll leave it to the IEA for the final say, “For prices, there may be light at the end of what has been a long, dark tunnel, but we cannot be precisely sure when in 2017 the oil market will achieve the much-desired balance. It is clear that the current direction of travel is the correct one, although with a long way to go.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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