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Waiting for the next bullish catalyst – but do sell the rally when/if it comes

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SEB - Prognoser på råvaror - CommodityMy key takeaways (Sales Summary)
Oil prices have been volatile lately due to the hurricanes in the U.S Gulf coast, with Brent testing the important support of $53/bbl yesterday, and confirmed it. The Brent front end curve is now again in backwardation. OPEC+ is standing firm on its cuts and they seem open to extending them beyond Q1-18. Oil inventories are declining and the number of US Shale Oil rigs have been declining for four weeks in a row and we believe this trend will continue. US crude production have fallen 700kbbl/d due to hurricane Harvey, which would result in a 5 mbbl outage if it lasts for a week. These factors together with low overall net long speculative positions makes us believe that there is great chance that oil prices will increase during H2. However, spikes should be good opportunities for producers to hedge as we believe there will be plenty of oil in 2018.


Price action – Testing support at $53/b – it held
Brent crude traded with some intraday noise yesterday fluctuating between gains and losses before settling up 0.1% on the day at $53.84/b. Intraday it traded down to $53.04/b which seems to have been a pure technical move to test the technical support at $53/b which it recently broke above. Following the price noise from the hurricanes in the U.S. Gulf the Brent crude oil curve is again back in backwardation at the front end of the curve. The WTI curve is however still left in solid contango as the bottlenecks created by Harvey are still problematic. The WTI to Brent November spread has moved out to $5.2/b. The WTI October contract closed up 1.2% ydy as some of the bottlenecks have started to clear but still closed as low as $48.07/b

Crude oil comment – Waiting for the next bullish catalyst – but do sell the rally when/if it comes
Brent crude is back in backwardation at the front of the curve. OPEC+ is standing firm on its cuts. It’s delivering on them and also seems open for extensions beyond 1Q18. Oil inventories are declining and front end crude prices and oil product curve structures are firming.

The number of US shale oil rigs declined by 5 rigs again last week to 605 rigs. It has now fallen four weeks in a row which is the first time since May 2016. We think this trend of declining US shale oil rigs is likely to continue towards the end of the year as there are too many rigs with completions struggling to catch up to drilling.

We do not think that this matters too much fundamentally with respect to the oil market balance in 2018 because there is such a large inventory of drilled but uncompleted wells to complete from. For the autumn however we think that seeing the number of drilling rigs declining when the WTI 1-2 year forward prices holds above $50/b could add a positive, bullish sentiment to the oil price: “See, WTI crude is above $50/b and rigs are declining! Shale oil players need a higher price to be profitable!” And maybe they do need a higher price in order to do what they do. That is at least the verdict of equity market which has punished the shale oil sector so far this year in lack of show of profits.

At the moment we also see that that US crude oil production has fallen back some 700 kb/d due to hurricane Harvey. If the outage lasts for a week it will shave 5 million barrels from global oil inventories. However, it will revive and rise strongly towards the end of the year in our view. Thus later in 4Q17 it could take away some of the current optimism of a firming oil market.

Hedge funds as of Tuesday last week had a fairly low overall net long position. I.e. there is quite a bit of room to the upside in terms of closing down shorts and adding length to their speculative positions.

North Korea has been in the news lately. What would happen to oil if a nuclear event developed is hard to say. For now we have sanctions of oil exports to North Korea on the table. This would of course reduce oil demand and so could be interpreted as potentially bearish. However, the magnitude of their consumption probably does not amount to more than some 20 kb/d. That is no more than the current weekly growth in US crude oil production (baring the recent set-back due to hurricane Harvey).

In the shorter term we have a constructive price situation. OPEC+ is firm on cuts, US shale oil rigs are declining, global oil inventories are declining, US crude production is currently down 700 kb/d, oil production in Libya has recently seen set-backs (though back up again now), hedge funds net speculative positions were at a low level last Tuesday. Technically the Brent crude price has broken up above the important $53/b level. It was tested as support yesterday and it held. Now Brent is set to test the $55.33/b level before the year to date high of $58.37/b (January 3rd) could be challenged.

However, we think there will be plenty of oil in 2018 with the need for OPEC+ to hold cuts through all of next year. Thus a bounce in crude oil prices near term should be utilized as an opportunity to hedged 2018 for the natural sellers, the producers. A new round of hard hitting hurricanes approaching the U.S. Gulf thus creating supply disruption risks could be the catalyst for such a bounce. A new and slightly longer set-back in Libya’s crude oil production could be another one. Producers and natural sellers should stay ready to utilize such a bounce.

Ch1: Brent crude front end curve back in backwardation
We have not had a lasting backwardation like this since 2014

Brent crude front end curve back in backwardation

Ch2: The WTI crude curve is still in contango however. Clogged with bottlenecks from hurricane Harvey

The WTI crude curve is still in contango however. Clogged with bottlenecks from hurricane Harvey

Ch4: Crude oil forward curves now and one week ago

Crude oil forward curves now and one week ago

Ch5: Hedge funds net long spec at low level as of Tuesday last week
Room to add length which would give bullish impetus to oil prices

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Hedge funds net long spec at low level as of Tuesday last week

Ch6: The spike in product cracks created by hurricane Harvey have fallen back

The spike in product cracks created by hurricane Harvey have fallen back

Ch7: OPEC is delivering on its pledge cuts

OPEC is delivering on its pledge cuts

Ch8: US implied shale oil rigs have fallen back 4 weeks in a row – first since May 2016

US implied shale oil rigs have fallen back 4 weeks in a row – first since May 2016

Ch9: US implied shale oil rigs falling back

US implied shale oil rigs falling back

Ch10: US crude oil production disrupted some 700 kb/d by hurricane Harvey
Shaving some 5 mb off global inventories if it lasts for a week

US crude oil production disrupted some 700 kb/d by hurricane Harvey

Kind regards

Bjarne Schieldrop
Chief analyst, Commodities
SEB Markets
Merchant Banking

Analys

Tightening fundamentals – bullish inventories from DOE

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The latest weekly report from the US DOE showed a substantial drawdown across key petroleum categories, adding more upside potential to the fundamental picture.

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

Commercial crude inventories (excl. SPR) fell by 5.8 million barrels, bringing total inventories down to 415.1 million barrels. Now sitting 11% below the five-year seasonal norm and placed in the lowest 2015-2022 range (see picture below).

Product inventories also tightened further last week. Gasoline inventories declined by 2.1 million barrels, with reductions seen in both finished gasoline and blending components. Current gasoline levels are about 3% below the five-year average for this time of year.

Among products, the most notable move came in diesel, where inventories dropped by almost 4.1 million barrels, deepening the deficit to around 20% below seasonal norms – continuing to underscore the persistent supply tightness in diesel markets.

The only area of inventory growth was in propane/propylene, which posted a significant 5.1-million-barrel build and now stands 9% above the five-year average.

Total commercial petroleum inventories (crude plus refined products) declined by 4.2 million barrels on the week, reinforcing the overall tightening of US crude and products.

US DOE, inventories, change in million barrels per week
US crude inventories excl. SPR in million barrels
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Bombs to ”ceasefire” in hours – Brent below $70

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A classic case of “buy the rumor, sell the news” played out in oil markets, as Brent crude has dropped sharply – down nearly USD 10 per barrel since yesterday evening – following Iran’s retaliatory strike on a U.S. air base in Qatar. The immediate reaction was: “That was it?” The strike followed a carefully calibrated, non-escalatory playbook, avoiding direct threats to energy infrastructure or disruption of shipping through the Strait of Hormuz – thus calming worst-case fears.

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

After Monday morning’s sharp spike to USD 81.4 per barrel, triggered by the U.S. bombing of Iranian nuclear facilities, oil prices drifted sideways in anticipation of a potential Iranian response. That response came with advance warning and caused limited physical damage. Early this morning, both the U.S. President and Iranian state media announced a ceasefire, effectively placing a lid on the immediate conflict risk – at least for now.

As a result, Brent crude has now fallen by a total of USD 12 from Monday’s peak, currently trading around USD 69 per barrel.

Looking beyond geopolitics, the market will now shift its focus to the upcoming OPEC+ meeting in early July. Saudi Arabia’s decision to increase output earlier this year – despite falling prices – has drawn renewed attention considering recent developments. Some suggest this was a response to U.S. pressure to offset potential Iranian supply losses.

However, consensus is that the move was driven more by internal OPEC+ dynamics. After years of curbing production to support prices, Riyadh had grown frustrated with quota-busting by several members (notably Kazakhstan). With Saudi Arabia cutting up to 2 million barrels per day – roughly 2% of global supply – returns were diminishing, and the risk of losing market share was rising. The production increase is widely seen as an effort to reassert leadership and restore discipline within the group.

That said, the FT recently stated that, the Saudis remain wary of past missteps. In 2018, Riyadh ramped up output at Trump’s request ahead of Iran sanctions, only to see prices collapse when the U.S. granted broad waivers – triggering oversupply. Officials have reportedly made it clear they don’t intend to repeat that mistake.

The recent visit by President Trump to Saudi Arabia, which included agreements on AI, defense, and nuclear cooperation, suggests a broader strategic alignment. This has fueled speculation about a quiet “pump-for-politics” deal behind recent production moves.

Looking ahead, oil prices have now retraced the entire rally sparked by the June 13 Israel–Iran escalation. This retreat provides more political and policy space for both the U.S. and Saudi Arabia. Specifically, it makes it easier for Riyadh to scale back its three recent production hikes of 411,000 barrels each, potentially returning to more moderate increases of 137,000 barrels for August and September.

In short: with no major loss of Iranian supply to the market, OPEC+ – led by Saudi Arabia – no longer needs to compensate for a disruption that hasn’t materialized, especially not to please the U.S. at the cost of its own market strategy. As the Saudis themselves have signaled, they are unlikely to repeat previous mistakes.

Conclusion: With Brent now in the high USD 60s, buying oil looks fundamentally justified. The geopolitical premium has deflated, but tensions between Israel and Iran remain unresolved – and the risk of missteps and renewed escalation still lingers. In fact, even this morning, reports have emerged of renewed missile fire despite the declared “truce.” The path forward may be calmer – but it is far from stable.

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A muted price reaction. Market looks relaxed, but it is still on edge waiting for what Iran will do

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Brent crossed the 80-line this morning but quickly fell back assigning limited probability for Iran choosing to close the Strait of Hormuz. Brent traded in a range of USD 70.56 – 79.04/b last week as the market fluctuated between ”Iran wants a deal” and ”US is about to attack Iran”. At the end of the week though, Donald Trump managed to convince markets (and probably also Iran) that he would make a decision within two weeks. I.e. no imminent attack. Previously when when he has talked about ”making a decision within two weeks” he has often ended up doing nothing in the end. The oil market relaxed as a result and the week ended at USD 77.01/b which is just USD 6/b above the year to date average of USD 71/b.

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

Brent jumped to USD 81.4/b this morning, the highest since mid-January, but then quickly fell back to a current price of USD 78.2/b which is only up 1.5% versus the close on Friday. As such the market is pricing a fairly low probability that Iran will actually close the Strait of Hormuz. Probably because it will hurt Iranian oil exports as well as the global oil market.

It was however all smoke and mirrors. Deception. The US attacked Iran on Saturday. The attack involved 125 warplanes, submarines and surface warships and 14 bunker buster bombs were dropped on Iranian nuclear sites including Fordow, Natanz and Isfahan. In response the Iranian Parliament voted in support of closing the Strait of Hormuz where some 17 mb of crude and products is transported to the global market every day plus significant volumes of LNG. This is however merely an advise to the Supreme leader Ayatollah Ali Khamenei and the Supreme National Security Council which sits with the final and actual decision.

No supply of oil is lost yet. It is about the risk of Iran closing the Strait of Hormuz or not. So far not a single drop of oil supply has been lost to the global market. The price at the moment is all about the assessed risk of loss of supply. Will Iran choose to choke of the Strait of Hormuz or not? That is the big question. It would be painful for US consumers, for Donald Trump’s voter base, for the global economy but also for Iran and its population which relies on oil exports and income from selling oil out of that Strait as well. As such it is not a no-brainer choice for Iran to close the Strait for oil exports. And looking at the il price this morning it is clear that the oil market doesn’t assign a very high probability of it happening. It is however probably well within the capability of Iran to close the Strait off with rockets, mines, air-drones and possibly sea-drones. Just look at how Ukraine has been able to control and damage the Russian Black Sea fleet.

What to do about the highly enriched uranium which has gone missing? While the US and Israel can celebrate their destruction of Iranian nuclear facilities they are also scratching their heads over what to do with the lost Iranian nuclear material. Iran had 408 kg of highly enriched uranium (IAEA). Almost weapons grade. Enough for some 10 nuclear warheads. It seems to have been transported out of Fordow before the attack this weekend. 

The market is still on edge. USD 80-something/b seems sensible while we wait. The oil market reaction to this weekend’s events is very muted so far. The market is still on edge awaiting what Iran will do. Because Iran will do something. But what and when? An oil price of 80-something seems like a sensible level until something do happen.

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