Crude oil prices likely to move higher as volatility hits over 3-year low

By Navneet Damani

Oil prices surged to upside last week after consolidating for four weeks driven by a solid combination of technical and fundamental factors. The key fundamental factors driving the price action last week were Middle East tensions, worries about Venezuela’s production slide, a surprise decline in US inventories and speculation that the Opec-led production cuts would be extended into 2019.

Traders paid little attention to forecasts of increased US production and an increasing rig count. Speculation that the US may reimpose sanctions on Iran helped boost prices because this would lead to a disruption of supply.

Opec and its allies achieved 138 per cent of pledged output reductions last month, Opec said, up from 133 per cent in January and the highest since the deal aimed at clearing a glut began in January 2017. Oil prices rallied, pushed up by Saudi plans for Opec and Russian led production curbs introduced in 2017 to be extended into 2019 in order to tighten the market.

Dollar lost ground in spite of market optimism about US growth, massive tax cuts, increased fiscal spending and three Fed rate hikes in 2017 — with more expected in 2018, which provided some support top crude prices.

The US central bank as expected raised its policy rate to 1.50-1.75 per cent, but disappointed currency traders who had bet it was prepared to raise rates four times this year as the jobs market approaches full employment.

US crude oil stockpiles fell unexpectedly last week as imports dropped and refining rates jumped, while gasoline and distillate inventories also declined. Crude imports dropped by half a million barrels per day that contributed to the draw. We saw refinery runs increase more than expected by around 4,00,000 barrels per day so that ate up a lot of crude. And exports were up slightly.

Crude inventories fell 2.6 million barrels in the week to March 16 compared with expectations for an increase of 2.6 million barrels. Stocks at the Cushing, Oklahoma, and delivery hub for US crude futures rose 905,000 barrels. Gasoline stocks fell 1.7 million barrels compared with expectations for a 2 million-barrel drop. Distillate stockpiles fell 2 million barrels, versus expectations for a 1.7 million barrels drop.

Data from API showed a surprise draw of 2.739 million barrels of US crude oil inventories for the week ending March 16 compared with expectation prior of a build of 2.556 million barrels in crude oil inventories.

Last week, API reported a modest build of 1.156 million barrels of crude oil, with a draw for gasoline that saw an inventory slip by 1.262 million barrels for the fuel. This week, the API reported another draw for gasoline. API reported draw of 1.0633 million in gasoline stockpiles, largely in line with the 2.008-million barrel draw, which was had expected.

Another factor that added to the bullish momentum was continuous fall of Venezuela’s oil production, and some of the dire production scenarios for the South American nation are no longer looking as remote as they once were. The reasons for the decline were an economic crisis that is only worsening, no cash for investment or even maintenance, a debt crisis, and US sanctions.

Falling production, where output has been halved since 2005 to below 2 million bpd due to economic crisis, will continue to support to oil price. Venezuela’s oil production fell by another 52,000 bpd in February from a month earlier. Venezuela’s oil production fell to just 1.548 million bpd in last month—a 52,400 bpd drop from January 2018. IEA reported that Venezuela was vulnerable to an accelerated decline and that the Latin American country could trigger a renewed drawdown in stocks which supported crude prices.

Data from Baker Hughes showed that the number of drilling rigs operating in US rose by four last week, bringing the total count to 804. It was the eights increase in the rig count in eight weeks. Fundamentals are strong as bullish news overshadowed increase in rigs.

President Trump appointment of John Bolton raises the odds of a clash with Iran and North Korea, and almost certainly will result in the withdrawal of the U.S. from the Iran deal.

Meanwhile, Trump is planning to withdraw the US from the accord between Tehran and six world powers, raising the prospect of new sanctions that could hurt Iran’s oil industry. The expectations of Trump and Prince Mohammed to take harder line on Iran are supporting prices.

However, Surging US crude production, which has risen by more than fifth since mid-2016, to 10.38 million bpd that has been disrupting the oil demand/supply imbalance, putting the US ahead of top exporter Saudi Arabia and within reach of Russia’s 11 million bpd. While global demand is expected to pick up quickly this year, supply is also growing at a faster pace leading to a rise in inventories in the first quarter of 2018 as per the IEA. So far, the market is sort of ignoring the increase in production and market will eventually reckon with this fact.

Outlook

There is strong momentum for prices to trade upside, but one factor that could stop the rally is the start of a trade war between the US and China in response to President Trump’s signing of a memorandum to impose sanctions on China for the theft of intellectual property.

Another factor that may slow down the rally was a rise in the weekly oil rig count. As reported by Baker Hughes, the weekly oil rig count rose by 4 to 804 in total, up 152 rigs from a year ago.

For now, traders seem comfortable with prices moving in a relatively narrow range around $ 67 per barrel for Brent, which is contributing to the fall in volatility to its lowest level since 2012-2014.

In the week ahead, market participants will eye fresh weekly information on US stockpiles of crude and refined products due this week to gauge the strength of demand in the world’s largest oil consumer and how fast output levels will continue to rise.

We are nearing a critical point as geopolitical tensions and tight balances will support crude prices. However, the size of any correction will be determined by seasonal factors.

Most of all, traders will be watching US PCE number to gauge strength for U.S economy. For the short term, we expect crude to remain positive and dollar to provide near term triggers. Technically, short-term bias looks to be between Rs 4,190-4,340 and a break above the same looks negative and the current rally could extend towards Rs 4,400. On the downside a slide below Rs 4,190 convincingly will open doors for below Rs 4,100 levels.

(Navneet Damani is AVP Research at Motilal Oswal Commodities. Views expressed in this article are author’s own and do not represent those of ETMarkets.com)