Phil Flynn On $70 Oil This Year Despite Head Winds

Energy expert discusses why he thinks the oil rally isn't over.

Phil Flynn is senior energy analyst and a futures account executive at Chicago-based The Price Futures Group. He is one of the world's leading energy market analysts and a daily contributor to Fox Business Network, where he provides market updates and analysis. Flynn recently sat down with ETF.com to discuss the latest developments in the oil market.

ETF.com: Oil surged from $26 to more than $51 before backing down slightly in the last few sessions. What's your take on the price action?

Phil Flynn: In the short term, we've pulled back a little bit because of the fear over the “Brexit” and fear about what the Fed may or may not do. That's weighed on market sentiment. But the things I was talking to you about a year ago―production destruction and lost investment―could drive us higher again.

Obviously, if the U.K. votes to leave the European Union, that could create turmoil that could push the EU into recession, and that would moderate our bullish forecast a little bit. But our sense is that despite the polls being very close, we think the U.K. is going to vote to stay; and if they vote to stay, I think you're going to get a really good rally at the end of the year.

We're still targeting that oil could hit $70 by the end of the year, maybe even close to $80. The reason we're so bullish is because if you look around the globe right now, everybody's talking about subpar economic growth―but if you look at the demand for oil, it's near record highs everywhere you look. If you look at India: record high demand. If you look at China: record high demand. Even here in the United States, gasoline demand has been at a record high.

Now, could you imagine what will happen if the economy starts to do a little better? Supplies could tighten a little bit―and this comes at a time when these major oil companies are canceling projects. They're still making big cutbacks and pulling in the reins.

Also, you still have some big financial problems at a lot of the smaller energy companies. A lot of them are continuing to file bankruptcy. A lot of them are cash-starved right now. Even though we've seen some stabilization in the rig count in the last two weeks, we think it's going to take some time for the U.S. shale patch to really ramp up production.

We get a sense that we’re in the process of falling behind the curve when it comes to the production-versus-demand argument, and we assume we're going to see the market further tighten as the year goes on.
If we can get through this next week without any other major disasters—whether it comes to the Brexit or the Fed meeting—the outlook looks pretty solid.

ETF.com: You've talked about how falling U.S. production is a major driver of this rally. Is output going to continue to drop, or will it come back now that prices are higher?

Flynn: We're down almost a million barrels a day from where we were a year ago. I think that number's going to continue to trend lower, and I could see a time where we're down 1.5 million barrels by this time next year. A lot of people think that because prices are up, all of a sudden this production is going to come back online―but the investment dollars aren't there to bring production on that quickly.

Just to get the rig count back up to where it was, you're going to have to add over 300 rigs. I don't see that happening by the end of the year. Plus, many of the longer-term projects that we would expect to give us long-term supply have been canceled; that's going to tighten supplies even more down the line.

ETF.com: What are supply fundamentals like outside the U.S.? Is OPEC still relevant?
Flynn: OPEC is relevant because it can move the market. The last OPEC meeting showed that it was closer to a deal to restrain production. But there's been a lot of turmoil. We've had a change in the leadership in Saudi Arabia; Ali al-Naimi is no longer the oil minister. We had a shakeup at the Iranian National Oil Company over the weekend. And some of the big players, like Venezuela and Nigeria, are having major problems right now.

My guess is that growth in OPEC production is going to disappoint over the next year and a half. The problems with Venezuela and Nigeria aren't going away, and it's going to be more difficult for Saudi Arabia, Iran and Iraq to continue to raise production because they're fighting in wars. They have lack of capital right now, so things are going to be more difficult for them.

The other market we have to focus on is natural gas. We've been in such a hurry to kill all the coal plants and shut them all down at a time when demand for natural gas is at a record high. That's going to create some challenges this summer and next winter. That's another market that, because of production destruction, is going to really face issues going forward.

ETF.com: What's the best way to play oil right now?

Flynn: It really depends on your risk tolerance. What we’ve been doing is we've been positioning for the long term. We've been looking at a combination of futures and long-term options. We've been buying contracts further out on the curve. That's probably the best way to play it, but it's also the most risky way to play it.

There's also a number of energy ETFs that you could possibly play. You could also look at individual energy companies, but if you do, make sure they’ve strong balance sheets, because there's going to be more pain before we start to see the gains in these companies. You have to be careful.

Editor’s note: See the energy ETF channel for a complete list of energy exchange-traded products.

Contact Sumit Roy at [email protected].