Analys
US crude recovery could cover all OPEC cuts
Over the last two weeks Brent crude has fallen close to $4/b. Market perception has shifted from “OPEC will do the job and US crude production will recover gradually” to instead “Can OPEC do the job? and US production is rebounding strongly”. The hypothesis that US crude oil production will only recover gradually and slowly as long as the oil price stays below $60/b has clearly fallen. The US EIA projects that US crude production will move above its April 2015 peak of 9.6 mb/d in February 2018. We think that this will happen already in October 2017. However, if we extrapolate the average weekly increase since the start of 2017 (+33.9 kb/d/week) we get that with a starting point of 9.1 mb/d on the 10th of March then US crude production will pass the 9.6 mb/d already in June 2017. Thus full attention to the US EIA’s weekly publishing of US crude production is clearly warranted.
If US production had only recovered slowly as long as the oil price stayed below $60/b, then it would easily have been in OPEC’s power to drive the oil price rather quickly back to $60/b. However, US shale oil rig count rose by 7 rigs per week in H2-17 when the WTI 15mth forward price averaged around $52/b in H2-16. When that part of the forward curve was pushed up to $55-56/b following OPEC’s decision to cut it lifted the weekly rig count additions to 9.2 rigs/week on average so far in 2017. Along with the latest sell-off the WTI 15mths price has now fallen back to $50.5/b. This can be interpreted as an effort by the market to push back the current acceleration in shale oil investments. If this price stays at this level of about $50/b then we won’t know the effect of this before some 6-8 weeks down the road which is the typical lag between price action to rig count reaction. Thus the growth in US shale oil rig count is likely to continue unabated all through April.
OPEC will meet on the 25th of May this year to discuss whether to continue its cuts or not. US crude oil production stood at 8.7 mb/d when OPEC decided to cut at its 30th November meeting in 2016. That was only 0.25 mb/b above the US crude production trough of 8.45 mb/d in July/August 2016. The general view then was clearly that US crude production would recover gradually. There would not be much acceleration unless the oil price moved up to $60/b. OPEC decided to cut 1.16 mb/d from its October production level which lead to a production target of 31.8 mb/d for H1-17. So far OPEC has cut 0.4 mb/d less than planned with an averaged Jan/Feb production of 32.2 mb/d. I.e. the organisation has cut some 0.8 mb/d versus its October 2016 level. Back in November a US crude production rebound was not even on the horizon and not much discussed. The US EIA’s monthly report only stretched out to the end of 2017 with a prediction that US crude production would hit 8.94 mb/d in Dec 2017 which was just 250 kb/d above the US crude production in November 2016.
Now it all looks different. If we look away from EIA’s projection of US hitting 9.6 mb/d in Feb 2018 and instead focus on the latest weekly production data of 9.1 mb/d and extend it with the growth trend so far this year then US production would hit close to 9.5 mb/d just when OPEC’s members meet on the 25th of May. US production would then have increased by close to 0.8 mb/d since OPEC decided to cut in November 2016. That is close to exactly what OPEC has cut in Jan and Feb. Thus if OPEC’s compliance to the decided cuts don’t rise from here then US crude oil production recovery could end up rising equaly much as OPEC ended up cutting. The previous oil minister in Saudi Arabia, Ali al-Naimi’s words that an OPEC cut would only yield a lower market share while not necessarily lift the oil price may start to ring in the back of the head of OPEC’s members. We don’t expect OPEC to extend its cuts into H2-17. We have this itching feeling that OPEC compliance to cuts may start to erode towards the end of H1-17. Especially if the expectation is that there will be no further cuts.
Speculative market repositioning helped to shift oil prices lower
The pullback in the oil price last two weeks was clearly a repositioning in speculative positions as holders of long positions started to be concerned about the increasingly visible strong US production recovery. Net long speculative positions in WTI reached close to 600 mb some 4 weeks ago but have now sold off back down to 500 mb. A more neutral level is however around 350 mb. Thus there is still risk for further bearish repositioning.
We still expect Brent crude at $57.5/b in Q2-17 before falling back to $52.5/b in Q4-17
We are still positive for crude oil prices into Q2-17 where we expect front month Brent to average $57.5/b. We expect to see inventories to start to draw any moment as OPEC’s elevated production in Nov and Dec now increasingly is assimilated. Global refineries are also now increasingly coming back on line thus starting to process crude oil again. As oil inventories continues to draw as it did all through H2-16 we expect the forward crude oil curves to flip fully into backwardation. This will then enable the Brent crude oil front month contract to move up to $57.5/b while still leaving the WTI 15mth contract at around $51-52/b. Our outlook for Q2-17 is however at risk if US crude oil production continues to grow at its current trend rate. We still expect Brent crude to head down to average $52.5/b in Q4-17 in order to cool US shale oil production growth.
We expect OECD inventories to draw down 160 million barrels in 2017
The market was disappointed when it heard from IEA that OECD inventories rose by 48 mb in January. In perspective however, OECD inventories normally increase by some 30 mb from Dec to Jan. Thus the increase in inventories was only 18 mb more than normal. What is striking is that OECD’s inventories trended downwards all through H2-16 and ended down y/y for the first time in a long, long time in both December and January. And this was even without the help of OPEC cuts. We still expect the oil market to run a deficit of some 0.4 mb/d in 2017 thus resulting in a steady draw in inventories. Thus we have passed the OECD peak inventories and we are now heading downwards. The higher activation of US shale oil rigs than expected over the last two to three months has however impacted our projected supply/demand balance for 2018 leading to virtually no deficit in 2018 and thus very limited draws. Thus 2018 look likely to be a waiting year for the oil market with still plenty of oil in OECD inventories and with few pressure points.
Ch1: OECD down y/y for the first time in a long time in Dec and Jan
We are past the peak OECD inventories. To draw down from here
Ch2: Strong US production growth recovery is posing a problem for OPEC
OPEC cuts unlikely to continue in H2-17 as US production may reach 9.5 mb/d already in late May (trend extrapolation)
Ch3: Latest sell-off has increased the depth of front end crude curve contango
This contango and discount for spot crude prices versus longer dated contracts is just what OPEC wants to get away from
The 1-2 year forward WTI curve has shifted down to $50/b which would reduce the profitability for new shale oil investments
Ch4: Net long speculative WTI positions has pulled back but are still high
Now standing at 500,000 contracts or 500 million barrels.
Neutral level would be around 350 million barrels
Ch5: OPEC production at 32.16 mb/d in Feb and thus some 350 kb/d above its target.
Will OPEC compliance fall apart if it becomes increasingly clear that there will be no cuts in H2-17?
Ch6: We still expect a deficit the next three years despite strong US production growth
The balance assumes no OPEC cuts after H1-17
Ch7: Due to current high OECD inventories the global oil market is fine all through 2017 and 2018.
Not a lot of pressure points to be seen before 2019
Ch8: And yes, we are bullish US crude oil production but even more than that is needed in 2019
Then it all boils down to “too little too late” or “too much too soon”.
The US EIA is lifting its prognosis every month all since last July.
We expect them to continue to do that going forward as well as the EIA prognosis is still way behind the curve in our view.
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.
Brent testing the 200dma at USD 78.6/b with API indicating rising US oil inventories
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