Where are oil prices heading?

After OPEC and non-OPEC members agreed to cut oil production in an attempt to drive up prices, we caught up with the Managing Director and Deputy Chief Investment Officer at Middlefield Group, Rob Lauzon, to get his thoughts on the agreement and to ask about where oil prices are headed.

“For two years, OPEC, which is really just Saudi Arabia, has played chicken with the US in trying to compete on market share and force the US to stop growing,” Lauzon says. “That has not worked as planned for the Saudis. The US was producing around 9.5 million barrels a day and, as oil dropped to $30 – $40 a barrel, US production went down to 8.5 million a day – not as big a drop as the Saudis had hoped. With new technology, the US managed to produce at a high level and compete and at the same time.”

For many years, when oil was comfortably $75 - $100 a barrel, Saudi Arabia would cut production when the $60 mark was threatened - but failed to do that when prices slumped in 2015. As well as hurting Nigeria, Angola and Venezuela, plunging oil prices also hit Saudi Arabia hard. With an ongoing war in Yemen to fund, and various domestic issues, the country needed to start boosting revenues.

“There’s lots going on in Saudi Arabia that led us to think that oil prices had to increase, which would only happen as a result of taking supply off the market,” Lauzon says. “We don’t think oil will go above $55 – $60 in the near term because it’s already gone from $35 – $50. We use a rule thumb: for every 100,000 barrels of oil taken off the market, the price should go up by a dollar. So, in theory, (with OPEC and non-OPEC members agreeing to take 1.5 million barrels off the market daily) that’s a $12 – $15 increase in oil price.”

That $15 dollar spike would put oil at just over $60 a barrel; something that Lauzon doesn’t believe to be realistic in the short-term. “US production will increase and everyone cheats anyway, so I think that 1.5 million barrels will be cut in half,” he says.  “Oil has been hugging the $46 – $47 range for a while, so $51 – $52 is probably the right price for now. If you believe everything from OPEC members, then oil would have spiked $15 dollars right away, to $60, but the market is not willing to believe that.”

Lauzon is currently managing portfolios based on this opinion; that realistically we’re in a $45-$60 oil environment. “Last year, we were making sure we owned companies that worked at $40 oil,” he says. “Now, we’re looking at $50 oil when identifying the names we can own, and we have added some based off of that.”

Lauzon also believes the cut in production, and the resulting ‘healing’ of the energy market, will have a positive impact on the general stock market. “There is less pressure on energy stocks and energy bonds,” he says. “There have been some high yield bonds issued by energy companies in the US in the last couple of weeks at an interest rate of 5.5%; a year ago they would have been 10%. The fear has come out of the market on the energy side and that’s good for the stock market. It’s important to have a healthy energy market in order to have a healthy stock market, and we’re seeing that.”