Price normalization is coming soon.
Price normalization is coming soon.

In the race to return to a stabilized marketplace rich with business incentives for investors and oil companies, normalization may be here sooner than expected.

Global financial services firm UBS released its latest report Jan. 20, outlining key insights gleaned from the geopolitical and economic landscape in 2016 and what kinds of lessons can be carried over into 2017. One of those key findings related to the oil industry and where prices are likely to end up in Q1 2017 – good news for oil: up!

This extrapolation is based on the larger trendlines that rounded out 2016 and are influencing decisions made by businesses and governments in today’s current environment.

Heating up without overheating
Analysts at UBS suggest benchmark oil prices should rise between $5 and $10 by the end of Q1 – but this is only if present-day realities are sustained.

Researchers found that OPEC is actually following through on its plans to curb production, the feasibility of which was hotly debated in past months. CNBC noted Saudi Arabia’s output is now down to 160,000 barrels per day while Kuwait and Qatar are producing just 20,000 bpd. Even further, Russia – a non-OPEC nation – is similarly making good on its promise to curtail production. Recent numbers suggest the oil-rich nation is cutting back twice as quickly as previous estimates surmised.

Overall, these factors have combined to form just such the landscape that analysts and investors were hoping for heading into 2017. And although this news is promising on the surface, UBS stated that it could be too good to be true if the market ends up overheating (prices rising too quickly, leading to additional turbulence).

Alexander Novak, Russia’s energy minister, stated if the U.S. stays out of the market rebound, inventory drawdowns may prove too volatile, according to CNBC.

“If U.S. supply is less responsive than we envisage, however, then there is the risk the market overtightens, sending Brent above our $60 to $80 per barrel incentive range and laying the foundations for another price cycle,” said Novak.

It’s not just the level of U.S. involvement that will be a strong determinant of rebalancing; China and India will likewise play outsized roles in corrective actions that may occur.

Stockpiling falling out of favor as prices rise
One of the core benefits of low prices over the past two years is that large oil-consuming nations were able to buy up reserves of oil on the cheap. China and India in particular were two culprits at the root of this strategy – the two countries have large populations yet don’t produce a lot of oil themselves. However, both countries intended to stockpile much of the oil they imported to be used at a more advantageous time, aka when prices rose.

As MarketWatch reported, prices have now, in fact, risen, which means oil importers are curbing their stockpiling efforts to save money on costs.

With less crude purchased by China and India, exporters will have fewer buyers and inventories will decline over time. This drawdown dovetails with OPEC and Russia’s reserve-draining practices of late.

On the whole, the world’s largest countries are collectively using up their reserves, forcing prices higher – a goal that has been front of mind for some time. But at some point in 2017, the confluence of supply and demand may inevitably result in a scenario where stockpiles may truly be depleted for some nations, which could trigger more purchasing to keep pace with energy demands and rising population levels.

The rate of inventory waning will certainly have to speed up for this setting to occur, and if it does, the true nexus point may not be in 2017 at all, but further down the road.

What’s integral to keep in mind is that all of the actions by oil’s major players will likely need to continue stably and predictably for many months to truly see how the market pans out. If the UBS report is any indication, oil’s future is certainly on the right track. But as discussed in previous posts, there are a slew of curveballs waiting to be thrown into playing field that could ostensibly derail further stabilization efforts, none of which is out of the realm of possibly due to the nature of the U.S.’s latest transfer of presidential power.

With these sorts of uncertainties still in the air, Forbes contributor Michael Lynch eschewed putting too much faith in oil’s latest developments without first looking at historical data. In practice, the market may simply be entering another era of de ja vu, where predictions of “peak demand” or “peak supply” have turned out to be inaccurate in year’s past.

Oil companies now face a price environment that suits their budgets better than at any time in recent years, and can largely expect even more promising margins ahead. Betting on a full price rally in the near term, however, may be a classic case of wishful thinking.