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US crude oil production, only a lower price can slow it down

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SEB - Prognoser på råvaror - CommodityPrice action – Long positions taking a hit – Pain trade to the down side

The front month Brent crude contract sold off 5% yesterday with a clos at $53.11/b. This was the lowest close for front month Brent since early December 2016 and clearly a break out of the close, sideways trend around $55/b which has been in place since OPEC decided to cut production in late November. Technically the Brent crude May 17 contract broke the important support level of $54.64/b. The next support level for the contract is $52.86/b and that has already been broken in today’s trading with Brent crude now trading at $52.3/b. Net long speculative positions are close to record high so if the bearish sentiment continues then oil prices are naturally and clearly vulnerable to the downside. That is where the pain-trade is.

It is worth mentioning that in a week on week perspective there has been a broad based sell-off in commodities in general with all sub-indices selling off between 2.6% and 4.4% and the total commodity index down 3.5%. In a week on week perspective Brent sold off 5.8% so a little more than the total energy index which sold off 3.9%. Still, oil was not alone in the sell-off. I.e. It was not just oil specific reasons for why oil sold off over the last week even though the sell-off came yesterday. In the background for all assets is the market concern for higher US interest rates which is hurting bonds, equities as well as commodities. Gold which is definitely sensitive to higher interest rates sold off 3.3% over the past week. The bullish US employment statistics yesterday probably helped to underpin the expectation for higher US rates.

Longer dated crude oil contracts also sold off yesterday with the Brent crude December 2020 contract closing yesterday at $53.74/b which is a new fresh low since April 2016. As stated earlier we expect this contract to trade yet lower down towards the $50/b mark in a pure neccessity to lower the implied shale oil profitability offered US shale oil players on a forward crude oil price curve. More than anything it is the one to three year forward contracts which needs to move lower in order to stemm the current strong rise in shale oil rigs and shale oil investments. Since OPEC decided to cut production in late November 2017 US shale oil players have been offered a nice profitable lunch on in the forward market basis.

Crude oil comment – US crude oil production, only a lower price can slow it down

The consequence of the increase in US oil rigs since the mid-May last year has now become alarmingly visible in US crude oil production. US crude oil production is growing. And it is growing strongly. That was one of the key bearish statistics in the US EIA’s data release yesterday. US crude oil production rose by 56 kb/d w/w to 9.088 mb/d. Sounds like little in the big picture but multiply by 52 weeks (if it is a steady trend rather than weekly noise) and you get a marginal, annualized US crude oil production growth rate of 2.9 mb/d. Since the start of 2017 the average US crude oil production growth has been +35 kb/d w/w. That equates to a marginal, annualized growth rate of 1.8 mb/d. We are in general very bullish US shale oil production growth. However, we had not expecte to see this level of growth rate before in September 2017.

There is only one way to slow down the US crude oil production growth and that is a lower oil price. Thus beside an overall bearish sell-off in commodities in general, the oil price is pushing lower. A marginal, annualized US crude oil production growth rate of 1.8 mb/d which we now have seen since the start of the year is too much, too early. The shale oil veteran Harrold Hamm this week said at the Cera Week in Houston that the current investment binge in US shale oil production will kill the oil market unless it is tempered. Pioneer’s Scott Sheffield was out earlier in the week stating that US Permian crude oil production could rise to 8-10 mb/d in 10 years time and thus surpas Saudi Arabia’s Ghawar field (biggest in the world today). He also said that the WTI crude oil price would fall to $40/b if OPEC doesn’t carry over its production cuts into H2-17. On top of this the US EIA revised its US crude oil production projections significantly higher yet again. We still think they are way behind the curve when they predict US crude oil production at 9.73 mb/d on average in 2018 versus our projection of 10.76 mb/d for that year. We thus think that the US EIA will revise higher its projections for US crude oil 2018 production projection again and again in 2017.

If US crude oil production continues to grow at the pace we have seen since the start of the year, then it will pass its past peak of 9.61 mb/d (which was reached in June 2015) by mid-June 2017. That is not our projection, just a pure mathematical extrapolation.

Shale oil service costs, labour costs and material costs are tellingly definitely on the rise. This could definitely slow down weekly rig count additions if the cost side starts to bit significantly. In that case the oil price would not need to move all that much lower in order to slow down rig count additions. However, we have not seen that effect yet. Normally there is a time lag of 6-8 weeks from the oil price moves to when we see a reduction or increase in the weekly US shale oil rig count numbers. As such even if the oil price now continues yet lower we are likely to see that the US shale oil rig count increases by 9-10 rigs every week the next 6-8 weeks.

We still think that oil inventories will fall in Q2-17 and as such give support to prices. Our expectations is to see the highest Brent crude oil price to be printed in Q2-17. However, US crude oil prodution is now growing so strongly that market focus is shifting away from OPEC cuts and over to US production growth. We had not expected this to happen before in late Q2-17.

Then we are left with the question – What will OPEC do in the face of strongly rising US crude oil production? The can decide to cut also in H2-17, but does it make sense? We think not. US shale oil production response is too fast and too flexible.

Ch1: Brent crude front month contract – Breaking the sideways trend. Back to pre-OPEC-cut-decission?

Brent crude front month contract

Ch2: US crude oil production rising strongly – too strongly. Now just 0.5 mb/d below prior peak
If it continues at this pace then US crude production will pass the 9.6 mb/d mark in June 2017

US crude oil production rising strongly

Ch3: Brent crude oil 1mth contract adjusted for US dollar strength since July 2013.
For all those longing for a Brent crude oil price of $60/b it is worth remembering that
if we adjust for the 23% stronger USD since July 2013 a Brent price today of only $51/b actually equals $63.6/b in 2013 USD terms.
In that perspective we are already “back above $60/b”. Acutally we were close to $70/b in 2013 dollar terms when Brent averaged $55/b so far this year.

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Brent crude oil 1mth contract adjusted for US dollar strength since July 2013.

 

Kind regards

Bjarne Schieldrop
Chief analyst, Commodities
SEB Markets
Merchant Banking

Analys

Brent prices slip on USD surge despite tight inventory conditions

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Brent crude prices dropped by USD 1.4 per barrel yesterday evening, sliding from USD 74.2 to USD 72.8 per barrel overnight. However, prices have ticked slightly higher in early trading this morning and are currently hovering around USD 73.3 per barrel.

Ole R. Hvalbye, Analyst Commodities, SEB
Ole R. Hvalbye, Analyst Commodities, SEB

Yesterday’s decline was primarily driven by a significant strengthening of the U.S. dollar, fueled by expectations of fewer interest rate cuts by the Fed in the coming year. While the Fed lowered borrowing costs as anticipated, it signaled a more cautious approach to rate reductions in 2025. This pushed the U.S. dollar to its strongest level in over two years, raising the cost of commodities priced in dollars.

Earlier in the day (yesterday), crude prices briefly rose following reports of continued declines in U.S. commercial crude oil inventories (excl. SPR), which fell by 0.9 million barrels last week to 421.0 million barrels. This level is approximately 6% below the five-year average for this time of year, highlighting persistently tight market conditions.

In contrast, total motor gasoline inventories saw a significant build of 2.3 million barrels but remain 3% below the five-year average. A closer look reveals that finished gasoline inventories declined, while blending components inventories increased.

Distillate (diesel) fuel inventories experienced a substantial draw of 3.2 million barrels and are now approximately 7% below the five-year average. Overall, total commercial petroleum inventories recorded a net decline of 3.2 million barrels last week, underscoring tightening market conditions across key product categories.

Despite the ongoing drawdowns in U.S. crude and product inventories, global oil prices have remained range-bound since mid-October. Market participants are balancing a muted outlook for Chinese demand and rising production from non-OPEC+ sources against elevated geopolitical risks. The potential for stricter sanctions on Iranian oil supply, particularly as Donald Trump prepares to re-enter the White House, has introduced an additional layer of uncertainty.

We remain cautiously optimistic about the oil market balance in 2025 and are maintaining our Brent price forecast of an average USD 75 per barrel for the year. We believe the market has both fundamental and technical support at these levels.

Oil inventories
Oil inventories
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Oil falling only marginally on weak China data as Iran oil exports starts to struggle

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Up 4.7% last week on US Iran hawkishness and China stimulus optimism. Brent crude gained 4.7% last week and closed on a high note at USD 74.49/b. Through the week it traded in a USD 70.92 – 74.59/b range. Increased optimism over China stimulus together with Iran hawkishness from the incoming Donald Trump administration were the main drivers. Technically Brent crude broke above the 50dma on Friday. On the upside it has the USD 75/b 100dma and on the downside it now has the 50dma at USD 73.84. It is likely to test both of these in the near term. With respect to the Relative Strength Index (RSI) it is neither cold nor warm.

Lower this morning as China November statistics still disappointing (stimulus isn’t here in size yet). This morning it is trading down 0.4% to USD 74.2/b following bearish statistics from China. Retail sales only rose 3% y/y and well short of Industrial production which rose 5.4% y/y, painting a lackluster picture of the demand side of the Chinese economy. This morning the Chinese 30-year bond rate fell below the 2% mark for the first time ever. Very weak demand for credit and investments is essentially what it is saying. Implied demand for oil down 2.1% in November and ytd y/y it was down 3.3%. Oil refining slipped to 5-month low (Bloomberg). This sets a bearish tone for oil at the start of the week. But it isn’t really killing off the oil price either except pushing it down a little this morning.

China will likely choose the US over Iranian oil as long as the oil market is plentiful. It is becoming increasingly apparent that exports of crude oil from Iran is being disrupted by broadening US sanctions on tankers according to Vortexa (Bloomberg). Some Iranian November oil cargoes still remain undelivered. Chinese buyers are increasingly saying no to sanctioned vessels. China import around 90% of Iranian crude oil. Looking forward to the Trump administration the choice for China will likely be easy when it comes to Iranian oil. China needs the US much more than it needs Iranian oil. At leas as long as there is plenty of oil in the market. OPEC+ is currently holds plenty of oil on the side-line waiting for room to re-enter. So if Iran goes out, then other oil from OPEC+ will come back in. So there won’t be any squeeze in the oil market and price shouldn’t move all that much up.

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Brent crude inches higher as ”Maximum pressure on Iran” could remove all talk of surplus in 2025

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Brent crude inch higher despite bearish Chinese equity backdrop. Brent crude traded between 72.42 and 74.0 USD/b yesterday before closing down 0.15% on the day at USD 73.41/b. Since last Friday Brent crude has gained 3.2%. This morning it is trading in marginal positive territory (+0.3%) at USD 73.65/b. Chinese equities are down 2% following disappointing signals from the Central Economic Work Conference. The dollar is also 0.2% stronger. None of this has been able to pull oil lower this morning.

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

”Maximum pressure on Iran” are the signals from the incoming US administration. Last time Donald Trump was president he drove down Iranian oil exports to close to zero as he exited the JCPOA Iranian nuclear deal and implemented maximum sanctions. A repeat of that would remove all talk about a surplus oil market next year leaving room for the rest of OPEC+ as well as the US to lift production a little. It would however probably require some kind of cooperation with China in some kind of overall US – China trade deal. Because it is hard to prevent oil flowing from Iran to China as long as China wants to buy large amounts.

Mildly bullish adjustment from the IEA but still with an overall bearish message for 2025. The IEA came out with a mildly bullish adjustment in its monthly Oil Market Report yesterday. For 2025 it adjusted global demand up by 0.1 mb/d to 103.9 mb/d (+1.1 mb/d y/y growth) while it also adjusted non-OPEC production down by 0.1 mb/d to 71.9 mb/d (+1.7 mb/d y/y). As a result its calculated call-on-OPEC rose by 0.2 mb/d y/y to 26.3 mb/d.

Overall the IEA still sees a market in 2025 where non-OPEC production grows considerably faster (+1.7 mb/d y/y) than demand (+1.1 mb/d y/y) which requires OPEC to cut its production by close to 700 kb/d in 2025 to keep the market balanced.

The IEA treats OPEC+ as it if doesn’t exist even if it is 8 years since it was established. The weird thing is that the IEA after 8 full years with the constellation of OPEC+ still calculates and argues as if the wider organisation which was established in December 2016 doesn’t exist. In its oil market balance it projects an increase from FSU of +0.3 mb/d in 2025. But FSU is predominantly part of OPEC+ and thus bound by production targets. Thus call on OPEC+ is only falling by 0.4 mb/d in 2025. In IEA’s calculations the OPEC+ group thus needs to cut production by 0.4 mb/d in 2024 or 0.4% of global demand. That is still a bearish outlook. But error of margin on such calculations are quite large so this prediction needs to be treated with a pinch of salt.

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