Historically, low interest rates have usually been beneficial to oil prices and an oil market recovery. Lower US interest rates tend weaken the dollar, which supports emerging markets and tempts investors to invest in riskier assets, all of which usually support oil. However, this relationship has changed recently due to shale. The rising US oil supply is a large factor weighing on prices.
This supply is primarily a function of exploration and production companies being allowed access to capital to fund drilling budgets that often significantly outpace their cash flow. Several E&P firms rushed to issue shares during the short rally in oil prices last month. To this point in 2015, 12% of US equity issuance has come from this sector, which is its highest proportion by a significant margin in the last twenty years as you can see from the graph above from the Wall Street Journal. According to Citigroup, total assets in Oil ETF’s have more than doubled since the start of the year. By continuing to bid up oil futures, that money also helps E&P firms sustain production. As long as oil investors only focus on low rates instead of rapidly growing inventories, they will delay the slowdown that is necessary to balance the market and sustain an actual rally.
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I feel like domestic producers might be “over-supplying” right now. As several other students have pointed out, the U.S is currently lacking storage for extra oil. On top of that, I think it is very unlikely that oil investors will somehow overlook the rapidly growing inventories and solely focus on low interest rates…
Who wouldn’t over-invest if it is cheap to do so and all of your competitors are as well.
With low interest rates, won’t it now pay more to leave oil in the ground? So perhaps some producers will pare back their output, helping prices. On the other hand, as this post indicates, there are also those who desperately need cash flow. That may include Saudi Arabia, with their large and comparatively poor population, and an economy where the oil sector has squeezed out manufacturing and other sectors that might otherwise create jobs.
We’ll see what happens with the storage issue. Some of those micro mismatch issues are amplified by the specialization of refineries in specific grades of petroleum.
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