Oil Rally Will Continue as Producers Curb Supplies. How to Play It.

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Increased global demand, together with recent supply cuts, could spark a more than 20% rally in oil prices this year, experts say.

“We expect prices to peak at $65 and remain in the range $55 to $65,” says
Art Hogan,
chief market strategist at

National Securities Corp.

in New York.Futures contracts for light sweet crude were recently fetching $53 a barrel on the Commodities Mercantile Exchange.

Traders wanting to profit from the potential rally should consider buying June-dated futures contracts for light sweet crude on the

CME.

Alternatively, they could try purchasing the

Invesco DB Oil

exchange-traded fund (ticker: DBO), which holds a basket of crude oil futures. The fund has gained 7.5% this year through Jan. 11. It lost 21% in 2020, according to

Morningstar.

This year crude has already rallied about 9%, due in part to an unexpectedly bullish move by OPEC+ (the Organization of the Petroleum Exporting Countries plus Russia) earlier this month.

The world’s second-largest producer, Saudi Arabia, surprised the world by announcing it would cut production in February and March by one million barrels a day (bpd). That move more than offset a combined 75,000 bpd increase for the same period by Russia and Kazakhstan.

Overall, the OPEC+ cut should help put a floor under prices, especially given that the member states will probably stick to their quotas. “We don’t see material risk to the group’s [OPEC’s] cohesion,”

Barclays

said in a recent report. Historically, OPEC members have often failed to stick to their production quotas, making price stability an issue.

Meanwhile, demand from China is higher than pre-pandemic levels. In the third and fourth quarters of 2020, the country consumed 13.7 million and 14 million bpd, respectively. That compares to an average of 13.3 million in 2019, according to OPEC.

Traders will likely bet on a rebound in demand for the rest of the world as Covid-19 vaccines allow people to return to business as usual. “My sense is that as we get back to a more normal society, we get a massive surge in people wanting to go flying and do things they could do before the pandemic,” says
Jon Rigby,
an oil analyst at UBS London. Such a scenario would mean an increase in oil demand, with air and land travel resulting in higher fuel consumption.

Oil prices will get an additional boost from a softer dollar. “My general view is that we won’t have a stronger dollar,” says
Steve Hanke,
professor of applied economics at Johns Hopkins University. “Automatically, a little bit weaker dollar will add a little bit of strength to the oil price.” Oil gets priced in dollars, which means that in general, when the dollar weakens, crude prices tend to rally.

A price rally will likely be tempered by increasing supply from shale producers in North America, says Hogan of National Securities. While the Biden administration will likely reduce drilling on federal lands, there is still a lot of potential supply ready to tap when crude prices approach $60. “There is plenty for us in the next two years to increase our supply with hydraulic fracking,” he says.

Buying any commodity futures contract is a risky endeavor, and oil futures are no exception. The price of crude is subject to influences by national governments, geopolitical upheaval, and changes in the global economy. All these can result in significant price volatility.

Despite that, the odds looked stacked in favor of a rally in crude prices over the next few months. “We see prices going higher, if not meaningfully higher,” says Daryl Jones, director of research at Hedgeye Risk Management.

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