What $50 oil means to producers and the Fed
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Fifty dollars a barrel isn’t a magic price that will send oil producers scrambling to ramp up output, but a move above that level could offer just the added excuse the U.S. Federal Reserve needs to raise interest rates.
Prices for West Texas Intermediate CLN6, +1.11% and Brent LCON6, +0.32% crude both managed to tap highs above the psychologically important $50-a-barrel level on Thursday.
Both benchmarks ultimately settled below $50, but it still marked the first time WTI has reached $50 since July and the first time Brent topped that level since November.
“That gives it another reason to hike interest rates in June,” he said. “A rate hike would, most likely, boost the strength of the dollar that, in turn, would pressure” WTI oil prices.
Growing expectations that the U.S. central bank will raise interest rates at its next meeting in June has buoyed the dollar, with the ICE U.S. Dollar Index DXY, +0.05% trading about 2.3% higher month to date. Overall, the stronger greenback has put pressure on dollar-priced commodities, particularly gold GCM6, +0.07% and at times, oil as well.
And “happy drivers [and] better consumer confidence are another reason why the Fed may feel more comfortable raising interest rates,” said Phil Flynn, senior market analyst at Price Futures Group.
But it isn’t necessarily the price level for oil that may prompt the Fed to act.
James Williams, energy economist at WTRG Economics, said he doesn’t believe that $50 oil will help convince the Fed to lift rates. After all, the central bank kept them low even when oil prices traded above $100 a barrel in 2014.
The direction of oil’s move may be what actually piques the central bank’s interest.
“I think the trend in oil prices may influence the Fed,” said Colin Cieszynski, chief market strategist at CMC Markets.
WTI oil futures suffered a drop of more than 30% last year, but have climbed roughly 34% so far this year.
“Oil trending lower [may push] down inflation, while oil on the rise may push up headline inflation and put pressure on the Fed to raise rates,” said Cieszynski. “The oil-price crash masked core inflation creeping higher for over a year.”
But with the prospect of oil settling above $50 sometime soon, the market appears to be more concerned with the prospect that the higher price may spur a big spike in crude production.
“The U.S. shale industry is a giant source of potential waiting on higher prices to return to production mode,” said Tim Evans, chief market strategist at Long Leaf Trading Group.
Research suggests that most firms need crude prices north of $60 a barrel to operate profitably, but some production may be able to come back online at prices over $50, he said.
Tom Kloza, global head of energy analysis at the Oil Price Information Service, told MarketWatch that the $50 a barrel number is “magical for some producers, but hardly magical at all for high cost drillers.”
The latest monthly report from the Energy Information Administration show expectations for a June production decline of 113,000 barrels a day to 4.848 million barrels a day for seven major U.S. shale regions.
Some of the shale wells might again be tapped if $50 a barrel or more “sticks around or ratchets a bit higher, but [the] die has already been cast” for a lot of producers outside of the Organization of the Petroleum Exporting Countries, in terms of cuts to capital expenditures and less drilling, Kloza said.
So despite rising prices for oil, production still has a chance of coming of short.
“The carnage that was left in the wake of the price crash has done long-term damage to future production prospects and that will mean we will have shortages down the road,” said Price Futures’s Flynn.
With all of that said, traders can be sure that the oil market will be focused on the outcomes of the June meetings for the Fed and OPEC, as well as what central bankers and oil producers say in the run up to those gatherings.
The OPEC meeting on June 2 could spark some volatility in prices, though expectations for any kind of deal are “pretty low now,” said Cieszynski.
Summer driving season demand are likely to be among the big factors as well, “so inventory reports may continue to have a big influence on trading,” he said.
Meanwhile, traders have been pricing in a greater likelihood that the Fed will raise rates by the next central bank meeting on June 14-15, said Evans.
Evans pointed out, however, that while the Fed keeps tabs on the oil price, he doesn’t believe the central bank “will move or not move based on that alone.”
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