Is it all over for oil price rally?

As anyone with even a passing interest in markets will have noted, oil has staged a fairly dramatic recovery of late.

The front month price on Brent Crude has surged from a low of $45 in January to a peak of $69 in just three months, helping to erase some of the hefty losses seen over the last 12 months.

Many investors will tell you oil is a screaming buy even at this level, and if the average price over the last decade is anything to go by then it still looks cheap.

The problem with this approach arises when you look further back, as the last decade is not particularly reflective of the oil market over the much longer term. Indeed, between the mid-1980s to 2003, the average inflation-adjusted price of oil was under $25 a barrel. If anything, it could be argued the last decade has been the anomaly, not the other way round.

This is exacerbated by the fact that all the data currently points to another sell-off for crude. An interesting piece from Bloomberg last week highlights five fairly major headwinds which anyone buying in now should be looking closely at.

In a series of compelling charts, the article shows the following: falling futures prices, all-time high reserves in the US, a huge spike in uncompleted wells (which, unlike sites yet to be drilled, simply need to be brought on-stream), near record output from the Saudis, and a jump in the amount of hedges being put in place at the current price by producers and traders (suggesting they expect a fall could be coming).

Oil market participants are not the only ones eyeing the recent recovery with more than a little caution. Kames Capital’s CIO Stephen Jones has warned investors are focusing too much on the weekly rig counts coming out of the States, and not enough on other factors.

“There has certainly been a meaningful increase in the number of US oil rigs halting production,” he said. “But what the count overlooks is that a lot of the rigs going offline are the inefficient producers who were only in operation because the high price of oil a year ago made it just about viable for them to survive.”

Short-term geopolitical events will always influence commodities, but even these appear to be having less of an impact these days. Partly this is because production has shifted from global hotspots like the Middle East to the US, which became the world’s largest oil producer in 2013 – dislodging Saudi Arabia – and the largest gas producer in 2012 after overtaking Russia.

Given the relative security of the region, it is little wonder each external shock to the system is moving the price less.

Where next?

Something that really could boost the oil price is a drop-off in the dollar’s strength, and certainly the greenback’s rally since the middle of last year was a major cause of the fall in price of most commodities. However, Jones says that risk is limited – for now. “It is hard to see what might derail that underlying strength in the near term, with the US’ expanding economy and the prospect of an interest rate rise this year all having driven the currency higher,” he said.

Investors, then, must tread carefully. After climbing 30% in the last three months, we could well see a pullback for oil, especially if short-term investors who have helped power the rise via ETFs decide they’ve made enough money already.