Bulls recover their confidence as US crude stocks draws lower

SEB - Prognoser på råvaror - CommodityOver the past week we have seen some sharp moves to the downside with Brent trading down to below $47/b before recovering. The sell-off was partly in a joint sell-off together with industrial metals. Possibly on the back of general commodity profit taking as some indications pointed to a peak in growth momentum.

There is clearly a widespread consensus that OPEC will roll cuts over into H2-17. The decision is however still ahead of us and as such is an uncertain element which creates some hesitation in the market. Better safe than sorry and as such we are likely to head into the meeting most likely at the low side of the prise spectre with a bounce up after the meeting with what now seems likely a positive decision by OPEC to roll cuts over into H2-17. Trading Brent crude at around $51-52/b ahead of the meeting with a jump up to $56/b post the meeting seems sensible.

We have seen some aired concerns that oil demand growth is coming in much weaker than expected with a growth rate as low as 0.8 mb/d y/y in H1-17. We find it hard to believe at the moment that there should be reason to be concerned for such a soft global oil demand growth in 2017. Overall oil demand growth is quite steady and fairly well related to overall global economic growth. In 2014 we had the exact same kind of concern where oil demand at times was estimated as low as 0.7 mb/d y/y. In hindsight though it has been adjusted up to 1.4% y/y for that year or +1.3 mb/d oil demand growth in 2014.

The US EIA on Tuesday released its monthly Short Term Energy Outlook (STEO) for May. It adjusted global supply up by 0.2% for both 2017 and 2018 while demand was lifted by 0.1% for each year. Net it saw a global surplus of 0.17 mb/d and 0.47 mb/d respectively for the two years. With a slightly higher projected surplus it adjusted its Brent and WTI price forecast down by 3% each for 2017 to $52.6/b and $50.7/b respectively for the two grades. The price forecast for 2018 was kept unchanged at $57.1/b and $55.1/b respectively for Brent and WTI. With a projected surplus for both 2017 and 2018 it naturally saw no draw down in OECD inventories neither in 2017 nor in 2018. It projected OECD ending stocks to end 2018 at 3109 mb which was 2.2% higher than in its April report and above the 2016 ending stock level of 2967 mb. Such an outlook should mean that the contango in the crude oil curves should be just as deep in 2017 as in 2018. It is a bit difficult to understand why they have a higher price forecast for 2018 than for 2017 when inventories are rising in 2018. The forecast for 2018 is actually 8.5% higher in 2018 than for 2017. The only explanation for such a view is that cost inflation will push prices higher.

US crude oil inventories yesterday showed a decline of 5.8 mb last week with gasoline declining 0.2 mb and distillates declining 1.6 mb. That gave the market back a lot of confidence. Total crude and product stocks in the US has actually been falling since mid-February but very high inventories for crude specifically has created lots of discomfort for the oil bulls this spring. Yesterday however some of those concerns were eased. The US EIA also estimated US crude production to be 9.3 mb/d last week (+21 kb/d w/w). In its STEO report on the EIA projected that US crude production would rise to 9.7 mb/d in November 2017 and thus pas its prior peak of 9.6 mb/d.

In perspective it is good to take a look at the current global rig count. It stood at 3656 rigs in 2014 while it stood at 2065 rigs in March according to OPEC. Also, it actually fell 42 rigs mth/mth from February. From 2014 to the latest count there is a drop of 43%. If we adjust for US shale oil volume productivity where today’s 600 shale oil rigs are as effective as 1200 rigs in 2014 we still get that the effective real decline in oil rigs is about 30% since 2014. Our ball-park figure is that only 20% of global upstream oil investments are needed to cover the global oil demand growth of some 1.3 mb/d y/y. The other 80% of upstream investments are basically used to produce oil that will counter declining production in existing production. The same goes for oil rigs. Only 20% of the rigs are needed to cover oil demand growth. The other 80% are needed to cover declines. Thus a 20% decline in real, global rig count will lead to no growth in global oil production. The above rig count does however not dissect between rigs used for prospecting versus rigs used to create production rigs. And as such the decline gives a misleading picture since prospecting for oil was the first to be cut in the downturn.

In the shorter term price picture we believe that Brent crude front month will head towards $51-52/b ahead of the OPEC meeting. Technically it then first out needs to break above $51.1/b and then more importantly above $51.67/b. Breaking above the later would technically be a goodbye to the downside technical correction we have had lately.

Kind regards

Bjarne Schieldrop
Chief analyst, Commodities
SEB Markets
Merchant Banking

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