This article was published by The McAlvany Intelligence Advisor on Friday, April 22, 2016:  

To the consternation of traders short the market, crude has jumped from $30 a barrel in late January to over $40 currently, with many indicators pointing to still higher prices. Was $30 the bottom? What will be the new ceiling?

Every bull market rises from the ashes of fear, disgust and despair. Traders and investors reasonably expected to bottom at well below $30, perhaps in the 20s, with some heavyweights, including Goldman Sachs, suggesting even lower prices. Some took short positions, certain that their calculus was correct: OPEC had maxxed out, American production seemed impervious to precipitous declines in rig counts, China’s was faltering and signs of were continuing to expose themselves around the globe, including the U.S. What could go wrong?

A little energy company, Callon Petroleum, showed exactly what could go wrong. Three times in the last six months the company has sold new shares to raise equity, and three times the company’s stock has risen. Logic and experience would suggest that dilution of shares would reduce their price. But with Callon, shares jumped from $4.21 in the middle of January to nearly $10 currently.

Digging more deeply it turns out that Callon isn’t the only company raising capital in the equity markets. In fact, North American energy exploration and production companies raised $18 billion last year, a record. And so far this year they have raised another $12 billion.

Add to the new equation this from the EIA (Energy Information Administration): US production will fall from 9.4 million barrels a day last year to an estimated 8.6 million this year and 8.0 million next year. The agency also predicted that $1.50 gas is history, that gasoline will average $1.94 for the rest of the year instead.

Add also this from Kuwait: when roughnecks there staged a strike last week, taking 1.8 million barrels off the market, the price of scarcely noticed. And while OPEC failed to come to any sort of agreement in Doha about freezing production, OPEC’s secretary has just announced that they are going to try again at their next meeting in June.

Short sellers, hoping to regain some of their losses, are no doubt liquidating their short positions, licking their wounds, and moving to the buy side. Frackers who have idled rigs by the hundreds are in the happy position of being able, within weeks, to restart them when the price of rises sufficiently. While it’s dangerous to make predictions (especially about the future, hat tip to Yogi Berra), there will be a new ceiling as US production comes back online. And it will be well below the $100 a barrel seen less than two years ago.

If $40 a barrel isn’t the new normal, it’s close. 

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Sources:

Marketwatch.com: How to make sense out of a confusing rally for oil futures

The Wall Street Journal: OPEC Secretary-General Says Cartel May Discuss Oil Freeze at June Meeting

The Wall Street Journal: Oil Firms Hit Pay Dirt

EIA’s April forecast for oil and natural gas

NYMEX crude 6-month price chart

Callon Petroleum three-month stock price chart

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