This is why you shouldn’t get excited about higher oil prices

When the price of an asset increases by nearly 60 percent in a matter of weeks, it’s usually a good time to sell. That’s true for oil right now.

Since the middle of February, WTI (or, West Texas Intermediate, a grade of oil whose price is used as a global benchmark) rallied from around US$26 per barrel to around US$40 per barrel as of late March, and is about US$38 now. But that’s still down 65 percent from 2014 highs.

As we said back in December, the oil price collapsed for the same reason that prices fall for anything else: There was more supply than demand. And the group of oil-producing countries that controls a lot of the world’s oil production, OPEC (Organization of the Petroleum Exporting Countries) hasn’t cut production at all. In fact, it has intentionally kept pumping out crude at near-record levels to keep its market share.

It’s been an expensive lesson in Economics 101. OPEC’s largest oil producer, Saudi Arabia, posted a US$98 billion budget deficit for 2015, which is a sky-high 15 percent of its GDP. It’s making less money from oil exports, which normally account for about 80 percent of the government’s total budget revenue.

Right now there is about 2 million barrels per day (bpd) of extra supply, in part because Iran, the world’s eighth-biggest oil producer, has been increasing the amount of oil that it’s producing. As we previously said, Iran’s increasing oil production means it will take even longer for global supply to match demand. Iran is trying to make up for all the oil it couldn’t export when it was dealing with economic sanctions, and is aiming to increase production by one third, to 4 million bpd.

Part of the recent recovery in oil prices stems from an anticipated OPEC meeting later this month with Russia to discuss an output freeze. But Russia, like Saudi Arabia, has been producing at near-record levels of 10 million bpd.

The meeting is to discuss a production freeze, not a cut. Keeping production at the same level isn’t going to help relieve the supply glut. Growth in Iran’s oil production will offset the minimal help of any production freeze by OPEC and Russia.

A potentially bigger problem is that some of the oil that Iran has produced hasn’t even hit the market yet. It’s having problems finding companies to insure its oil cargoes, so in February it had about 40 million barrels of oil in storage waiting to be shipped. That’s about six weeks of production by Iran. Once that does come available, it will put more pressure on the price of oil.

Meanwhile, in the U.S., now the world’s largest oil producer, the active oil rig count fell to 362 for the week ended April 1, down 47 percent from last year, according to oilfield services company Baker Hughes.

And one report estimated that 35 percent of public oil exploration and production companies around the world are very likely to go bankrupt this year, including many U.S. shale producers.

That there’s less oil production in the U.S. is a good thing for oil prices. But that doesn’t mean that the extra supply that’s pressuring prices is going away anytime soon.

Oil prices peaked last year at around US$60 per barrel because at that level, a lot of U.S. shale oil became profitable (it was unprofitable below that level). Since then, though, the U.S. shale industry has been getting more efficient. Instead of needing a breakeven price of around US$60/barrel, it’s dropped for many shale producers to $40-45 per barrel.

This means that shortly after the oil price moves up to that level, there will be more production from shale producers. And as we’ve already seen, in the oil market – as in other markets – a small amount of extra supply can have a big effect on prices.

There’s a “just right” price that benefits the global economy and strikes a balance between oil producers and consumers. As we recently said, this Goldilocks price is probably higher than where oil is now. But oil companies (and OPEC members) don’t care about what’s best for the global economy – they’re focused on their own profits. So the price of oil probably won’t move up much more this year.

That means oil companies aren’t a great investment, especially after share prices have increased in recent weeks. And markets where the recovery in the price of oil has helped – like Russia – are probably in for some disappointment.