Bulls & bears fight for control of crude oil market; production numbers key

By Navneet Damani

Crude oil prices continued to surge after brief consolidation amid a tightening physical market and inventory drawdowns. Prices found support after reports of Saudi plans for Opec and Russian-led production curbs introduced in 2017 to be extended into 2019 to further tighten the market.

Inventories continued to play a dominant role, as after some drawdown during the start of the month, markets saw sudden buildup of inventories and again huge drawdown in inventories.

The buildup in crude inventories comes amid a slowdown in refinery activity, which tends to reduce demand for crude, as refiners remained in a period of maintenance. The ramp up in US production, meanwhile, continued as the EIA confirmed domestic production rose to 10.43 million barrels a day, renewing investor fears that rising domestic output will dent Opec and its allies efforts to cut global supplies to the five-year average.

The EIA monthly report reported that world’s appetite for crude would increase by 1.5 million bpd to reach 99.3 million barrels day in 2018, an upward revision of 90,000 barrels. The uptick is expected to be driven by robust demand in industrialised nations, including Europe, the US and Japan. The global oil supply came down slightly in Feb in monthly terms to 97.9 million bpd, but was still up 740,000 barrels compared with a year earlier.

The IEA expects supply growth this year to be driven by countries outside Opec. Non-Opec supply is expected to increase by nearly 1.8 million bpd in 2018, with 1.5 million barrels coming from US crude production.

US crude oil production in January reached 9.96 million barrels per day, almost the same level as that in December 2017. EIA has increased its estimates for global production and demand in 2018. Production is seen at 100.34 million barrels per day, up from 100.01 million previously, with demand at 100.11 million, compared with 99.96 million.

During the month, US President Trump picked John Bolton as national security adviser and Mike Pompeo as secretary of state, two officials who have advocated regime change in Iran, making a sharply hawkish foreign-policy turn. That’s led to speculation that the US will withdraw from a deal between western powers and the Persian Gulf state under which sanctions were removed on Iran in return for a curbing of its nuclear programme. Further worries surrounding the Middle East have emerged after Saudi Arabia intercepted missiles fired by Tehran-backed Houthi rebels in Yemen.

Meanwhile, Saudi Arabia and Russia are working on a historic long-term pact that could extend controls over world crude supplies by major exporters for many years. For Opec, the grouping and non-Opec producers led by Russia agreed to extend oil output cuts until the end of 2018, as they try to finish clearing a global glut of crude while signalling a possible early exit from the deal if the market overheats.

Opec also decided to cap the combined output of Nigeria and Libya at 2017 levels below 2.8 million bpd. Both countries have been exempt from cuts due to unrest and lower-than-normal production. This bought positive sentiment in market and while investors are assessing the political landscape, oil producers are persisting in their efforts to limit supplies.

For most of 2018, the front-month WTI contract has remained in a state of backwardation. We expect this choppiness to continue in the oil markets for some more time. The factor that could move the market in bearish mode is if the on-going negotiations between the US and China end without a compromise then President Trump is likely to follow-through on his threat to impose sanctions on China. This could be potentially bearish for crude oil. If there is a compromise and stocks rally then look for crude to be underpinned.

Meanwhile, bullish news of Venezuela’s reduction in crude output to 1.38 million bpd by the end of 2018 added to sentiments. The main impact of this reduction will be seen in decline to exports of crude to US and would translate into more crude storage declines in US and increase its deficit.

From now on, market will largely be focusing on production and inventory data and with prices in the midst of a bull bear territory; we expect that there is going to be a see-saw trend with no major directional clarity.

(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)