The Motley Fool

Why Oil Prices Have Yet to Stabilize and Are Becoming Increasingly Volatile

West Texas Intermediate (WTI) recently climbed over the US$60 per barrel threshold and is hovering around that price. A number of pundits claim that oil prices have stabilized. However, while it may be difficult to predict the direction of oil prices with any certainty, I believe this claim couldn’t be further from the truth. 

Now what?

There are growing signs that the current rally will be short lived and that oil prices will again decline. This is because it will take a significant uptick in global demand for oil to alleviate the global supply glut created by rising U.S. unconventional oil production and OPEC’s refusal to cut output.

Currently, the global supply glut exceeds demand by about two million barrels of crude daily, and I don’t expect this to change anytime soon.

You see, growing demand for crude is dependent upon an uptick in global economic activity. With the outlook for China, the world’s second-largest economy, growing more uncertain, coupled with the Eurozone being caught in a deep economic slump, it is difficult to see demand for crude increasing in the foreseeable future.

Of even greater concern is that the volume of oil currently being pumped globally will increase. This is despite the U.S. rig count being down by just over 1,000 rigs since its November 2014 peak, and the growth of U.S. oil production continues to decline as producers shutter wells. In April 2015 alone, global oil supplies were 3.2 million barrels higher than they had been in the same month the previous year and they will only continue to grow.

Now, with the price of crude having rallied by 33% from its six-year low, OPEC is more determined than ever to grow output despite the global supply glut in order to ensure that its market share continues to grow. Saudi Arabia recently reported that it has boosted output to the highest level in three decades. Along with Kuwait and the U.A.E, Saudi Arabia is set to grow investments in oil exploration and development further in 2015.

Then there is the threat of Iran boosting production by up to one million barrels daily if sanctions are eased.

On top of this is the fracklog, or additional 300,000+ barrels of daily production currently sitting underground in the U.S. in drilled but uncompleted wells. Now, with WTI hovering at around US$60 per barrel, there is considerable incentive for oil producers to start pumping that crude. 

So what?

This makes it imperative for investors to avoid those energy companies, such as Penn West Petroleum Ltd. (TSX:PWT)(NYSE:PWE), with weak balance sheets, mediocre assets, declining oil production, and high operational costs. I am also inclined to avoid oil explorers and small oil producers that are still developing their oil assets, such as Athabasca Oil Corp. (TSX:ATH) or Black Pearl Resources Inc. (TSX:PXX).

There is also the negative impact the oil rout is having on the Canadian economy and the housing market in the energy patch. This makes it important for investors to avoid those companies with extensive direct or indirect exposure to the energy patch. This includes regional bank Canadian Western Bank (TSX:CWB), which has 42% of its mortgages located in Alberta and loans to the oil industry totaling $600 million.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Matt Smith has no position in any stocks mentioned.

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