There’s no stopping crude rally if Opec fails to curb output cuts

By Navneet Damani

Oil prices rallied in first half of the month followed by some slide in the second half. The market was influenced by mixed news where despite all the bullish commentary around oil prices in recent weeks, there was plenty of forewarning that prices were primed for a setback.

The major headlines which kept market entertained for the whole month was tightness of global supply, especially in light of Venezuela’s woes and the possible curtailment of Iranian exports, rising importance of the US as an exporter, and Opec commentary on crude output cuts.

For Saudi and the rest of Opec and their Russian allies, the trick was to ensure that crude prices remain anchored as close to $ 80 a barrel as possible, which seems to be a level that is a good compromise between meeting the fiscal needs of the producers without being high enough to prompt too much demand destruction.

Meanwhile, they also had to balance the geopolitics of oil, striking a balance between their need for relatively high prices against the support of US President Donald Trump in their struggle against regional rival Iran.

On export front, US exports have touched record and are expected to head to Asian countries in next couple of months. The US is set to export 2.3 million barrels per day (bpd) in June, of which 1.3 million bpd will head to Asia. This will eat away share of Russia and other producers in Opec. For China, its single largest refiner Sinopec has bought about a record 16 million barrels (533,000 bpd) of US crude, cutting down on Saudi imports in order to lower the US trade deficit.

US exporters are exporting as much as they can now, because they can fetch higher prices internationally considering the wide price gap between WTI crude versus Brent. The rise in exports has been spectacular. However, if US crude exports to Asia do surge to more than one million bpd in the coming months, this could provide the Saudis and the Russians with an added incentive to make more oil available to the market, and at a more competitive price.

China insatiable thirst for crude has made it world’s largest oil importer for crude, surpassing U.S. in annual gross crude oil imports in 2017 by importing 8.4 million barrels per day bpd compared with 7.9 million bpd of US crude oil imports due to new refinery capacity and strategic inventory stockpiling, combined with declining domestic production.

Meanwhile, imports from India are expected to jump 24 per cent to $ 109 billion from $ 88 billion last financial year, which will create demand for crude oil prices.

The major factor for such high exports was the widening of spread between WTI and Brent. The spread, between Brent and WTI is close to $ 9 per barrel, with premium to Brent, as it is supported by global supply risks, while WTI was bogged down by relentless increase in shale oil production. It suggests that everyone if going to want to buy US crude oil on the cheap, which means that exports could spike in the coming months.

The US oil exports already hit a new record and the trend is clearly up. For most of 2018, US weekly oil exports have been hovering around the 2 mbd range and are expected to average around 2.3 mbd in June. On long term basis, US exports will continue to rise in the medium term, and by 2022, country will be fourth biggest oil exporter in world behind Saudi Arabia, Russia and Iraq.

The US production is getting vital importance, as oil rigs were increasing through the month and have touched their highest level since March 2015. Permian Basin production has been rising by about 70,000 barrels a day in past few months, which translates to an increase of some 800,000 barrels a day by the end of this year, which will keep pressure high on crude oil prices, but the flow of crude is coming faster than energy companies can build pipelines to move it to refining and port hubs near Houston and Corpus Christi.

It has created a bottleneck as the new capacity won’t come online till 2019, and can constraint the supply of crude in markets. Meanwhile, the intention of Russia and other Opec countries to raise oil production by some one million barrels a day which will ease 17 months of strict supply curbs to offset the losses from Venezuela and Iran is keeping pressure on crude oil prices.

On flip side, the sanctions imposed by President Trump on Iran has created deficit in market and has been one of the major reason for price rally. It is expected that a supply reduction of between 300,000 to 500,000 bpd, while exports from the country were expected to drop by maximum of 700,000 bpd by the first half of 2019. The nation currently produces 3.8 million bpd.

Although Iran may find other buyers for its crude and the sanctions don’t go into effect for 180 days, companies have started curtaining shipping driven by insurance availability, which had a significant impact when sanctions were in effect previously. So even if Iran finds willing buyers, transporting the oil may be problematic.
Along with that, the continuous losses from Venezuela are helping prices. Venezuela’s oil production currently sits at around 1.4 mbd with estimates showing a further decrease to 750,000 barrels to 1.3 mbd.

Meanwhile, while plunging output in Venezuela captures oil world’s attention, problems are quietly festering in another Opec nation of Angola. Crude oil production in Angola is falling rapidly on lack of investments in offshore fields and this could tip the oil market into deficit.

The latest Monthly Oil Market report by Opec reveals that in the first quarter, Angola produced 1.574 million bpd of crude, down from 1.633 million bpd in the final quarter of 2017. In March, average daily production was lowest for quarter, at 1.524 million bpd, down by 81,700 bpd from February and it is believed the decline will continue, and even accelerate.

Markets will be waiting for meeting between Opec and non-Opec producers which are touted as key to outlook for crude oil prices and will meet in June to assess market conditions to discuss a tapering of production curtailments in order to maintain market balance now that global oil inventories have declined to the five-year average. To be sure, any reduction in Iranian exports could have an outsized impact on the oil market, which has become tighter amid higher demand and Opec’s concerted effort to restrain production.

We expect WTI crude oil prices on the NYMEX to trade in a broad range of $ 64 and $ 70 for much of the month. It is too early to say that the market has topped out, and another leg up could be seen on fallout of the Opec meet scheduled during the month. On the MCX, prices are likely to be range bound between Rs 4,200 to Rs 4,700.

(Navneet Damani is AVP Research at Motilal Oswal Commodities)