Analys
The long game is the wrong game (from short term intervention to longer term structural battle)
OPEC yesterday decided to roll existing cuts over for another 9 months lasting all the way to March 2018. Maintaining production cuts also in Q1-18 was however communicated as a measure mainly to avoid driving inventories higher again in the demand wise seasonally weak first quarter of the year. To the surprise of many the market did not take the deal well and Brent crude oil fell $4.6% to a close of the day of $51.46/b with a low of the day of $51.03/b.
In hindsight we can now clearly say that there must have been a substantial amount of anticipation in the market for not only an extension of cuts but also for deeper cuts. Saudi Arabia’s communication to the market ahead of the meeting has clearly been misinterpreted when he stated that OPEC “will do whatever it takes” to draw inventories down to the 5 year average. The market view must have been that what OPEC & Co. did in H1-17 was far from enough. Thus “whatever it takes” should be MORE. Thus the moment Khalid Al-Falih said to reporters in Vienna yesterday at 10:20 CEST that “deeper cuts are not needed”, that was when the oil price started to fall. Long speculative positions which had run hard into the meeting and then instead ran for cover when the oil price started to tumble.
When OPEC launched the cuts last year they were dubbed as a “short term intervention”. Now it increasingly starts to look like a long haul structural battle. We do think that OPEC’s decision to cut will drive inventories down towards normal by the end of the year. Thus yesterday’s decision by OPEC & Co. is in our view making $60/b a sensible target for the front month Brent crude at the end of 2017. Thus as such we think that yesterday’s sell-off should be used as a buying opportunity. At the same time however it is likely leading to another 9 months during which a positive crude oil price signal leads US shale oil production to accelerate yet more.
US shale oil production has accelerated massively since November when OPEC & Co. decided to cut production. US crude oil production is now up more than 600 kb/d since the start of December 2016 which is more than the total 558 kb/d in pledged cuts from the 11 countries which have joined OPEC in cutting production at the moment. Their cuts are now basically wiped out. The US shale oil stimulus from the price gains following OPEC’s decision to cut in November has added some 250 shale oil rigs to the market. If we assume that there will not be a single additional US shale oil rig added to the market from July 2017 and all through to the end of 2018 we still expect that US crude oil production will grow by 0.5 mb/d y/y in 2017, 1.5 mb/d y/y in 2018 and by 1 mb/d y/y in 2019. However, as a consequence of the extension of the cuts all until March 2018 we are likely going to see a more supportive oil price and thus yet more US shale oil rigs being added to the market over the coming 9 months of cuts. In our view this is likely going to flip the global supply/demand balance for 2018 and 2019 into surplus.
Thus OPEC is increasingly painting itself into a corner. OPEC’s choice next year will be
1) Roll some cuts forward in both 2018 and 2019 (longer term structural battle) or
2) Put 1.8 mb/d of production cuts (OPEC & Co.) back into the market. Produce at will and let the price regulate the market yet again. I.e. the oil price needs to drop in order to push non-OPEC production lower in order to make room for OPEC & Co’s production revival.
It is often said that generals always fight the previous war meaning that they use tactics and strategy from the last war because that is what they know even if these are outdated. In a way this is what OPEC & Co are doing. In a shale oil world they should have med the cuts quick and dirty. It should definitely have been a short term intervention and not a long term structural battle. In the old days when non-OPEC production solely consisted of conventional oil production with a lead time from investments to production of some 5 years then gradual, enduring cuts did work. Now however keeping cuts going just leaves US shale oil producers all the time in the world to respond and revive. Rather than OPEC & Co cutting 1.8 mb/d for a full 5 quarters (2017 + Q1-18) they should rather have cut production by 3 mb/d for one quarter. That would have left little time for US shale oil players to ramp up investments and thus have limited the cumulative production impact on 2018 and 2019.
At yesterday’s meeting they should have decided massive cuts in Q3-17 and then no more. That would have been the right medicine for the market. Draw down the inventories in a flash. No lengthy time for US shale oil producers to revive and voila, inventories down to normal. A flat or backwardated crude oil forward curve where the mid-term WTI forward curve could be kept in check from there onwards.
It is still not too late for Saudi Arabia to follow this kind of strategy. They have basically promised what they are going to produce over the next 9 months. They could possibly do all of it in Q3-17. Rather than placing production at 10.06 mb/d for 9 months (a cut of 486 kb/d) they could instead produce 9.07 mb/d for the three months in Q3-17 which would mean a cut of 1.458 kb/d versus its October 2017 level. That would have drawn the inventories down by an additional 90 mb in Q3-17. At the same time Saudi Arabia should sell a comparable amount of volumes on a forward basis 2018 and 2019. This would help to prevent the medium term forward curve from rising. Thus again limiting the price signals and hedging opportunities for US shale oil producers.
Khalid Al-Falih has said that US shale oil producers are not the enemy. He welcomes their production revival. However, it still needs to be managed in the right way. At least as long as OPEC & Co is trying to manage the market. And the right way in our view is quick and dirty cuts. Do it all in one go rather than extended and do manage the price level of the mid-term forward crude oil prices.
JPM this morning cut its 2018 Brent crude oil price outlook to $45/b. That is great news for OPEC & Co because it will help to hold price expectations low for 2018 and 2019 and thus help to keep the mid-term forward crude prices in check and thus help to limit the positive price signals to US shale oil producers and thus limit further strong additions and activations of rigs.
As of now however the picture is for a lengthy nine months of additional production cuts and thus more US shale oil rigs being activated driving both 2018 and 2019 into surplus. As such there is increasing concern in the market for the exit from cuts. It is easy to take 1.8 mb/d off the market (1.2 mb/d for OPEC and 0.6 for Co.). With further revival of US shale oil it will be increasingly difficult to put the volumes back into the market again. An exit strategy was not discussed at the OPEC meeting. “We will cross that bridge when we get there” was Khalid Al-Falih’s comment. The market is worried however that come April 2018 then OPEC & Co moves back to “produce at will”. If that was the case following 5 quarters of US shale oil stimulating production cuts from OPEC & Co that would mean that the front month Brent crude oil price probably would have to move down to $35/b in order to slow down US shale oil production again.
With increasingly a surplus becoming the likely outlook for 2018 and 2019 (due to nine more months of cuts) the price outlook for these years increasingly becomes tied to OPEC & Co’s strategy of rolling cuts yet further down the road or not.
For now we are positive to oil prices for the rest of the year in 2017 where we expect OECD inventories at normal level at the end of 2017 with the Brent crude curve moving into backwardation with the front end contract standing at $60/b. We then expect the market price structure to be as follows. The WTI 18 month contract standing at $52.5/b. The Brent crude 18 month contract standing at a $2.5/b premium at $55/b and lastly the front month Brent crude oil contract having a $5/b premium backwardation the 18 months contract thus placing Brent crude front month contract at $60/b at year end 2017.
We are however increasingly concerned about the oil market balance and thus oil prices in 2018 and 2019. The fact that Algeria’s Energy Minister, Noureddine Bouterfa, was replaced in a minister re-shuffle yesterday is concerning. He was at the heart of last year’s negotiations. He was the oil diplomat which criss-crossed between OPEC and non-OPEC members to make the production cut deal last year happen. Thus losing him as oil minister is probably not a good thing with respect to further cuts beyond March 2018.
Global supply/demand oil market balance:
This is what OPEC hopes for:
This is however probably what they might get:
Kind regards
Bjarne Schieldrop
Chief analyst, Commodities
SEB Markets
Merchant Banking
Brent touching down to the 200dma. Brent crude traded down for a fifth day yesterday with a decline of 0.4% to USD 70/b. This morning it has traded as low as USD 78.6/b and touched down and tested the 200dma at USD 78.6/b before jumping back up and is currently trading up 0.2% on the day at USD 79.1/b.
The Dubai 1-3mth time-spread is holding up close to recent highs. The 1-3mth time spreads for WTI and Brent crude have eased significantly. The Dubai 1-3mth spread is however holding up close to latest high. Indian refiner Bharat is reported to struggle to get Russian crude for March delivery (Blbrg). The Biden-sanctions are clearly having physical market effects. So, the Dubai 1-3mth time-spread holding on to recent high makes a lot of sense. I.e. it was not just a spike on fears.
US oil inventories may have risen 6 mb last week (API). Actual data later today. The US DOE will release US oil data for last week later today. The US API last night indicated that US crude and product stocks may have risen close to 6 mb last week. This may be weighing on the oil price today.
Brent and WTI 1-3mths time-spreads have fallen back while Dubai is holding up
Brent crude is no longer overbought. Down touching the 200dma before bouncing back up a lilttle.
Analys
Crude oil comment: Deferred contracts still at very favorable levels as latest rally concentrated at front-end
Bouncing up again after hitting the 200dma. Bitter cold winter storm in Texas adding to it. Brent crude continued its pullback yesterday with a decline of 1.1% to USD 79.29/b trading as low as USD 78.45/b during the day dipping below the 200dma line while closing above. This morning it has been testing the downside but is now a little higher at USD 79.6/b. A bitter cold winter storm is hitting Texas to Floriday. It is going to disrupt US nat gas exports and possibly also US oil production and exports. This may be part of the drive higher for oil today. But maybe also just a bounce up after it tested the 200dma yesterday.
Some of the oomph from the Biden-sanctions on Russia has started to defuse with arguments running that these sanctions will only delay exports of Russian crude and products rather than disrupt them. The effects of sanctions historically tend to dissipate over time as the affected party finds ways around them.
Donald criticizing Putin. Biden-sanctions may not be removed so easily. In a surprising comment, Donald Trump has criticized Putin saying that he is ”destroying Russia” and that ”this is no way to run a country”. Thus, Donald Trump coming Putin to the rescue, removing the recent Biden-sanctions and handing him a favorable peace deal with Ukraine, no longer seems so obvious.
Deeper and wider oil sanctions from Trump may lift deferred contracts. Trump may see that he has the stronger position while Putin is caught in a quagmire of a war in Ukraine. Putin in response seems to seek closer relationship with Iran. That may not be the smart move as the US administration is working on a new set of sanctions towards Iranian oil industry. We expect Donald Trump to initiate new sanctions towards Iran and Venezuela in order to make room for higher US oil production and exports. That however will also require a higher oil price to be realized. On the back of the latest comments from Donald Trump one might wonder whether also Russia will end up with harder sanctions from the US and lower Russian exports as a result and not just Iran and Venezuela. Such sanctions could lift deferred prices.
Deferred crude oil prices are close to the 70-line and are still good buys for oil consumers as uplift in prices have mostly taken place at the front-end of the curves. Same for oil products including middle distillates like ICE Gas oil. But deeper and lasting sanctions towards Iran, Venezuela and potentially also Russia could lift deferred prices higher.
The recent rally in the Dubai 1-3 mth time-spread has pulled back a little. But it has not collapsed and is still very, very strong in response to previous buyers of Russian crude turning to the Middle East.
The backwardation in crude is very sharp and front-loaded. The deferred contracts can still be bought at close to the 70-line for Brent crude. The rolling Brent 24mth contract didn’t get all that much lower over the past years except for some brief dips just below USD 70/b
ICE Gasoil rolling forward 12mths and 24mths came as low as USD 640/ton in 2024. Current price is not much higher at USD 662/ton and the year 2027 can be bought at USD 658/ton. Even after the latest rally in the front end of crude and mid-dist curves. Deeper sanctions towards Iran, Russia and Venezuela could potentially lift these higher.
Forward curves for Brent crude swaps and ICE gasoil swaps.
Nat gas front-month getting costlier than Brent crude and fuel oil. Likely shifting some demand away from nat gas to instead oil substitutes.
Brent crude was already ripe for a correction lower. Brent closed down 0.8% yesterday at USD 80.15/b and traded as low as USD 79.42/b intraday. Brent is trading down another 0.4% this morning to USD 79.9/b. It is hard to track and assign exactly what from Donald Trump’s announcements yesterday which was impacting crude oil prices in different ways. But crude oil was already ripe for a correction lower as it recently went into strongly overbought territory. So, Brent would probably have sold off a bit anyhow, even without any announcements from Trump.
Extending the life of US oil and gas. The Brent 5-year contract rose yesterday. For sure he wants to promote and extend the life of US oil and gas. Longer dated Brent prices (5-yr) rose 0.5% yesterday to USD 68.77/b. Maybe in a reflection of that.
Lifting the freeze on LNG exports will be good for US gas producers and global consumers in five years. Trumps lifting of Bidens freeze on LNG exports will is positive for global nat gas consumers which may get lower prices, but negative for US consumers which likely will get higher prices. Best of all is it for US nat gas producers which will get an outlet for their nat gas into the international market. They will produce more and get higher prices both domestically and internationally. But it takes time to build LNG export terminals. So immediate effect on markets and prices. But one thing that is clear is that Donald Trump by this takes the side of rich US nat gas producers and not the average man in the street in the US which will have to pay higher nat gas prices down the road.
Removing restrictions on federal land and see will likely not boost US production. But maybe extend it. Donald Trump will likely remove restrictions on leasing of federal land and waters for the purpose of oil and gas exploration and production. But this process will likely take time and then yet more time before new production appears. It will likely extend the life of the US fossil industry rather than to boost production to higher levels. If that is, if the president coming after Trump doesn’t reverse it again.
Donald to fill US Strategic Reserves to the brim. But they are already filled at maximum rate. Donald Trump wants to refill the US Strategic Petroleum Reserves (SPR) to the brim. Currently standing at 394 mb. With a capacity of around 700 mb it means that another 300 mb can be stored there. But Donald Trump’s order will likely not change anything. Biden was already refilling US SPR at its maximum rate of 3 mb per month. The discharge rate from SPR is probably around 1 mb/d, but the refilling capacity rate is much, much lower. One probably never imagined that refilling quickly would be important. The solution would be to rework the pumping stations going to the SPR facilities.
New sanctions towards Iran and Venezuela in the cards but will likely be part of a total strategic puzzle involving Russia/Ukraine war, Biden-sanctions on Russia and new sanctions on Iran and Venezuela. All balanced to end the Russia/Ukraine war, improve the relationship between Putin and Trump, keep the oil price from rallying while making room for more oil exports of US crude oil into the global market. Though Donald Trump looks set to also want to stay close to Muhammed Bin Salman of Saudi Arabia. So, allowing more oil to flow from both Russia, Saudi Arabia and the US while also keeping the oil price above USD 80/b should make everyone happy including the US oil and gas sector. Though Iran and Venezuela may not be so happy. Trumps key advisers are looking at a big sanctions package to hit Iran’s oil industry which could possibly curb Iranian oil exports by up to 1 mb/d. Donald Trump is also out saying that the US probably will stop buying oil from Venezuela. Though US refineries really do want that type of oil to run their refineries.
Big money and USD 80/b or higher. Donald Trump holding hands with US oil industry, Putin and Muhammed Bin Salman. They all want to produce more if possible. But more importantly they all want an oil price of USD 80/b or higher. Big money and politics will probably talk louder than the average man in the street who want a lower oil price. And when it comes to it, a price of USD 80/b isn’t much to complain about given that the 20-year average nominal Brent crude oil price is USD 77/b, and the inflation adjusted price is USD 102/b.
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