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Crude oil comment – The risk is to the downside: $35/b before $45/b

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  • SEB - Prognoser på råvaror - CommodityCrude oil comment – The risk is to the downside: $35/b before $45/b
  • Graph 1: Contango likely to deepen again
  • Graph 2: As the market is still running a solid surplus
  • Graph 3: Temporary Dated Brent tightness is softening again
  • Graph 4: Price gains have managed to extend somewhat to the longer dated contracts
  • Graph 5: US oil rig count still lower despite now 8 weeks since price headed higher

Crude oil comment – The risk is to the downside
Two key drivers which have been important for the price rally to $40/b are fading. The 600 kbpd oil pipeline from northern Iraq to Ceyhan on the Mediterranean coast of Turkey is now repaired and only awaits a go signal from Baghdad. Together with the outage of Forcados in Nigeria it helped to tighten up the Brent spot market and thus assist the financial Brent crude oil rally with net long speculative positions now at record high. While still awaiting a go from Baghdad, the pipeline is likely to come back any day. The “production freeze discussion” between OPEC/Russia now holds no hope of creating any changes on the supply side. We never had any hopes for these discussions. Nonetheless, the fact that Saudi Arabia joined in on the discussions created some hope in the market that something might materialize from this in terms of restrained supply. It is however becoming more and more evident for everyone that this will come to nothing with latest statement from Iran: “Leave us alone. We’ll talk when we are back at 4 mbpd (now 3 mbpd)”.

The market is running a solid surplus. Looking at the weekly data so far this year it basically looks like a 2 mbpd surplus and just as big as last year. Yes, the market is now rebalancing. US production is declining and non-OPEC is declining, but as of yet it is not enough. Over time it is a contradiction to have increasing inventories and a flattening oil curves. Speculative positioning can shift it substantially out of shape for periods, but it will have to move back to reflect fundamentals again. If the flatter curve persists, then physical oil will have to leave inventories as economics can no longer support holding theme there. As the surplus persists we think that the contango will have to deepen again with front contracts coming lower again versus longer dated contracts in order to maintain oil inventory economics.

Since the end of December last year the net long speculative positioning in Brent and WTI has increased by 250,000 contracts equalling 250 million barrels. On the other side of this speculative equation are the physical producers. If the oil price now falls back $10/b down to $30/b again then the financial community will have handed the physical producers some $2.5bn in much needed funding.

In terms of the possibility for further oil price gains we think that it will be increasingly difficult for the oil price to move from $40/b to $50/b as there as far as we can see is an accelerating number of shale oil activities which becomes profitable as the oil price moves through this price span up to $50/b. Note also that if the Brent 1mth contract moves to $50/b then due to the contango in the oil price curve this will typically place the WTI Cal-2017 at $55/b. This should be perceived as a very nice price for many US shale oil producers to hedge at.

All told. There is increasing headwind for the oil price to move to the upside from $40/b. In addition the oil price is losing two key supportive elements which helped it move higher. The Ceyhan pipeline will come back any day and the “production freeze” discussion will just go away. Add solid, running surplus and rising oil inventories, too much flattening of the oil price curves and record high net long speculative positioning and voila, we are set to move to the downside. We are likely to see $35/b before we see $45/b.

Contango likely to deepen again

Brent and WTI prices

As the market is still running a solid surplus with stocks in weekly data growing some 2 mbpd year to date
However, crude and product stocks in weekly data declined last week:

Numbers

Crude and product stocks

Temporary Dated Brent tightness is softening again

Brent

Price gains have managed to extend somewhat to the longer dated contracts

Brent

US oil rig count still lower despite now 8 weeks since price headed higher

US oil rig

Oil

Bjarne Schieldrop
Chief analyst, Commodities
SEB Markets
Merchant Banking

Analys

Sell the rally. Trump has become predictable in his unpredictability

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Hesitant today. Brent jumped to an intraday high of $66.36/b yesterday after having touched an intraday low of $60.07/b on Monday as Indian and Chinese buyers cancelled some Russian oil purchases and instead redirected their purchases towards the Middle East due to the news US sanctions. Brent is falling back 0.4% this morning to $65.8/b.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

It’s our strong view that the only sensible thing is to sell this rally. In all Trump’s unpredictability he has become increasingly predictable. Again and again he has rumbled about how he is going to be tough on Putin. Punish Putin if he won’t agree to peace in Ukraine. Recent rumbling was about the Tomahawk rockets which Trump threatened on 10 October and 12 October to sell/send to Ukraine. Then on 17 October he said that ”the U.S. didn’t want to give away weapons (Tomahawks) it needs”.

All of Trump’s threats towards Putin have been hot air. So far Trump’s threats have been all hot air and threats which later have evaporated after ”great talks with Putin”. After all these repetitions it is very hard to believe that this time will be any different. The new sanctions won’t take effect before 21. November. Trump has already said that: ”he was hoping that these new sanctions would be very short-lived in any case”. Come 21. November these new sanctions will either evaporate like all the other threats Trump has thrown at Putin before fading them. Or the sanctions will be postponed by another 4 weeks or 8 weeks with the appearance that Trump is even more angry with Putin. But so far Trump has done nothing that hurt Putin/Russia. We can’t imagine that this will be different. The only way forward in our view for a propre lasting peace in Ukraine is to turn Ukraine into defensive porcupine equipped with a stinging tail if need be.

China will likely stand up to Trump if new sanctions really materialize on 21 Nov. Just one country has really stood up to Trump in his tariff trade war this year: China. China has come of age and strength. I will no longer be bullied. Trump upped tariffs. China responded in kind. Trump cut China off from high-end computer chips. China put on the breaks on rare earth metals. China won’t be bullied any more and it has the power to stand up. Some Chinese state-owned companies like Sinopec have cancelled some of their Russian purchases. But China’s Foreign Ministry spokesperson Guo Jiakun has stated that China “oppose unilateral sanctions which lack a basis in international law and authorization of the UN Security Council”. Thus no one, not even the US shall unilaterally dictate China from whom they can buy oil or not. This is yet another opportunity for China to show its new strength and stand up to Trump in a show of force. Exactly how China choses to play this remains to be seen. But China won’t be bullied by over something as important as its oil purchases. So best guess here is that China will defy Trump on this. But probably China won’t need to make a bid deal over this. Firstly because these new sanctions will either evaporate as all the other threats or be postponed once we get to 21 November. Secondly because the sanctions are explicit towards US persons and companies but only ”may” be enforced versus non-US entities.

Sanctions is not a reduction in global supply of oil. Just some added layer of friction. Anyhow, the new sanctions won’t reduce the supply of Russian crude oil to the market. It will only increase the friction in the market with yet more need for the shadow fleet and ship to ship transfer of Russian oil to dodge the sanctions. If they materialize at all.

The jump in crude oil prices is probably due to redirections of crude purchases to the Mid-East and not because all speculators are now turned bullish. Has oil rallied because all speculators now suddenly have turned bullish? We don’t think so. Brent crude has probably jumped because some Indian and Chinese oil purchasers of have redirected their purchases from Russia towards the Mid-East just in case the sanctions really materializes on 21 November.

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Analys

Brent crude set to dip its feet into the high $50ies/b this week

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Parts of the Brent crude curve dipping into the high $50ies/b. Brent crude fell 2.3% over the week to Friday. It closed the week at $61.29/b, a slight gain on the day, but also traded to a low of $60.14/b that same day and just barely avoided trading into the $50ies/b. This morning it is risk-on in equities which seems to help industrial metals a little higher. But no such luck for oil. It is down 0.8% at $60.8/b. This week looks set for Brent crude to dip its feet in the $50ies/b. The Brent 3mth contract actually traded into the high $50ies/b on Friday. 

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

The front-end backwardation has been on a weakening foot and is now about to fully disappear. The lowest point of the crude oil curve has also moved steadily lower and lower and its discount to the 5yr contract is now $6.8/b. A solid contango. The Brent 3mth contract did actually dip into the $50ies/b intraday on Friday when it traded to a low point of $59.93/b.

More weakness to come as lots of oil at sea comes to ports. Mid-East OPEC countries have boosted exports along with lower post summer consumption and higher production. The result is highly visibly in oil at sea which increased by 17 mb to 1,311 mb over the week to Sunday. Up 185 mb since mid-August. On its way to discharge at a port somewhere over the coming month or two.

Don’t forget that the oil market path ahead is all down to OPEC+. Remember that what is playing out in the oil market now is all by design by OPEC+. The group has decided that the unwind of the voluntary cuts is what it wants to do. In a combination of meeting demand from consumers as well as taking back market share. But we need to remember that how this plays out going forward is all at the mercy of what OPEC+ decides to do. It will halt the unwinding at some point. It will revert to cuts instead of unwind at some point.

A few months with Brent at $55/b and 40-50 US shale oil rigs kicked out may be what is needed. We think OPEC+ needs to see the exit of another 40-50 drilling rigs in the US shale oil patches to set US shale oil production on a path to of a 1 mb/d year on year decline Dec-25 to Dec-26. We are not there yet. But a 2-3 months period with Brent crude averaging $55/b would probably do it.

Oil on water increased 17 mb over the week to Sunday while oil in transit increased by 23 mb. So less oil was standing still. More was moving.

Oil on water increased 17 mb over the week to Sunday while oil in transit increased by 23 mb. So less oil was standing still. More was moving.
Source: SEB graph and highlights, Vortexa data

Crude oil floating storage (stationary more than 7 days). Down 11 mb over week to Sunday

Crude oil floating storage (stationary more than 7 days).  Down 11 mb over week to Sunday
Source: SEB graph and highlights, Vortexa data

The lowest point of the Brent crude oil curve versus the 5yr contract. Weakest so far this year.

The lowest point of the Brent crude oil curve versus the 5yr contract. Weakest so far this year.
Source: SEB graph and highlights, Bloomberg data

Crude oil 1mth to 3mth time-spreads. Dubai held out strongly through summer, but then that center of strength fell apart in late September and has been leading weakness in crude curves lower since then.

Crude oil 1mth to 3mth time-spreads. Dubai held out strongly through summer, but then that center of strength fell apart in late September and has been leading weakness in crude curves lower since then.
Source: SEB graph and highlights, Bloomberg data

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Analys

Crude oil soon coming to a port near you

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Rebounding along with most markets. But concerns over solidity of Gaza peace may also contribute. Brent crude fell 0.8% yesterday to $61.91/b and its lowest close since May this year. This morning it is bouncing up 0.9% to $62.5/b along with a softer USD amid positive sentiment with both equities and industrial metals moving higher. Concerns that the peace in Gaza may be less solid than what one might hope for also yields some support to Brent. Bets on tech stocks are rebounding, defying fears of trade war. Money moving back into markets. Gold continues upwards its strong trend and a softer dollar helps it higher today as well.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

US crude & products probably rose 5.6 mb last week (API) versus a normal seasonal decline of 2.4 mb. The US API last night partial and thus indicative data for US oil inventories.  Their data indicates that US crude stocks rose 7.4 mb last week, gasoline stocks rose 3.0 mb while Distillate stocks fell 4.8 mb. Altogether an increase in commercial crude and product stocks of 5.6 mb. Commercial US crude and product stocks normally decline by 2.4 mb this time of year. So seasonally adjusted the US inventories rose 8 mb last week according to the indicative numbers by the API. That is a lot. Also, the counter seasonal trend of rising stocks versus normally declining stocks this time of year looks on a solid pace of continuation. If the API is correct then total US crude and product stocks would stand 41 mb higher than one year ago and 6 mb higher than the 2015-19 average. And if we combine this with our knowledge of a sharp increase in production and exports by OPEC(+) and a large increase in oil at sea, then the current trend in US oil inventories looks set to continue. So higher stocks and lower crude oil prices until OPEC(+) switch to cuts. Actual US oil inventory data today at 18:00 CET.

US commercial crude and product stocks rising to 1293 mb in week 41 if last nights indicative numbers from API are correct.  

US commercial crude and product stocks rising to 1293 mb in week 41 if last nights indicative numbers from API are correct.
Source: SEB graph and calculations, Bloomberg data, US EIA data, API indicative data

Crude oil soon coming to a port near you. OPEC has lifted production sharply higher this autumn. At the same time demand for oil in the Middle-East has fallen as we have moved out of summer heat and crude oil burn for power for air-conditioning. The Middle-East oil producers have thus been able to lift exports higher on both accounts. Crude oil and condensates on water has shot up by 177 mb since mid-August. This oil is now on its way to ports around the world. And when they arrive, it will likely help to lift stocks onshore higher. That is probably when we will lose the last bit of front-end backwardation the the crude oil curves. That will help to drive the front-month Brent crude oil price down to the $60/b line and revisit the high $50ies/b. Then the eyes will be all back on OPEC+ when they meet in early November and then again in early December.

Crude oil and condensates at sea have moved straight up by 177 mb since mid-August as OPEC(+) has produced more, consumed less and exported more.

Crude oil and condensates at sea have moved straight up by 177 mb since mid-August as OPEC(+) has produced more, consumed less and exported more.
Source: SEB graph and highlights, Vortexa data, Bloomberg data feed.
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