Oil prices have risen more than 40% this year and even briefly touched $70 per barrel. But what is causing the recent upward trajectory? And can it continue to climb from here? Let’s take a look at some possible explanations and also the risks that lie ahead.

Current status of Oil Prices

Crude oil futures contracts extended their upward rally, and oil prices hit a multi-year high recently. As a reminder, A futures contract is a legal agreement between buyer and seller to exchange an asset like oil at a predefined date and price. Brent Crude Oil for August settlement touched $72.46 levels, and the WTI Crude Oil price for July settlement reached $70.32. In other words, oil has reached its highest point since 2018.

The US Energy Information Administration (EIA) recently provided its monthly Short Term Energy Outlook report. It forecasted a decline in the US crude oil production of 230,000 barrels per day this year, bringing the total to 11.08 million barrels. As a result of this reduced supply, the EIA expects the Brent crude oil spot prices to average around $65.19 per barrel by the end of 2021. This might be less than current levels, but it is a significant increase from its May forecast of $62.26 per barrel.

Catalysts of the upward rally of Oil Prices

To me, it seems investors remain highly confident about global economic growth. This, coupled with large-scale vaccinations worldwide, along with the easing of travel restrictions, makes me believe the oil demand will continue to rise.

What’s more, the market appears to be anticipating a delay in the US-Iran negotiations. And so it could be quite some time before sanctions on Iranian oil are lifted and the barrels enter circulation.

Consequently, I’ve spotted something interesting happening. Call options data on oil suggests that commodity traders expect the oil prices to rise to $100 per barrel by the end of 2022. As a reminder, call options are the financial contracts that give the option buyer the right to purchase the crude oil futures at $100 per barrel. Thus, the option buyers will benefit if the prices rise above the strike price of $100 a barrel before expiry.

Almost more than 60,000 crude oil contracts, representing 60 million barrels, are outstanding with a $100 strike price and December 2022 contract expiry – making it by far the most widely owned WTI call option on the New York Mercantile Exchange.

Potential Risk Factors for Oil Prices Uptrend

I believe two primary risk factors might stall the oil rally and even push it substantially downwards. One, slow-pace vaccinations and the resurgence of covid cases in major countries may result in extended lockdowns and travel restrictions. Consequently, this would likely reduce oil demand in the near future.

The second risk is the potential issue of oil oversupply by OPEC+ countries. Oil-producing nations have suffered a lot due to the pandemic. But now that oil is back above $70, there is now a lucrative incentive to pump out oil faster. This situation can result in an excess supply of oil and hence push prices back down.

The bottom line

Whether oil prices will reach $100 per barrel, only time will tell. But personally, I am quite optimistic. However, since my investment thesis is based on commodity prices, I think the best strategy for me would be to invest in more broad-based instruments like an exchange-traded fund instead of individual companies like Tullow Oil.  Funds do have their disadvantages – namely, the management fees. But the added security from diversification makes these fees acceptable, in my opinion.

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