Opec output hike no clear trigger for crude, but volatility may rise

By Navneet Damani

Oil saw a volatile session last week, as prices enjoyed their biggest daily gain since November 2016, but they still closed 1 per cent lower for the week. Combination of bullish and bearish news drove market for the whole week. Oil prices soared after oil producers agreed to modest crude output increases to compensate for losses in production at a time of rising global demand.

In the much awaited OPEC meet last week in Vienna, producers agreed to raise output from July by about 0.6 to 0.8 million bpd. The real increase, however, will be around 770,000 bpd because several countries that recently suffered production declines will struggle to reach full quotas, while other producers may not be able to fill the gap. The actual output increases set a bullish tone, as they came in below some of highest figures that had been discussed prior to the meeting.

Saudi appeared to have emerged as the winners from last week’s meeting of the Opec, and the subsequent talks between Opec and its allies in the deal to restrict output. Given that the Saudi Arabia, the world’s largest crude exporter, is going to have to provide the lion’s share of any increase in output, watching its export numbers and price signals in the coming months will be important. In fact, the Saudis already are supplying more crude. Saudi seaborne crude exports were 7.06 million bpd in May, the most in a year.

Saudi Arabia’s exports of gasoline were around 350,000 bpd in the first four months of this year. That’s up by around 100,000 bpd from last year’s average. Saudi shipments of gasoil averaged just less than 800,000 bpd in the January to April period, about 200,000 bpd more than for 2017. For all oil products, Saudi Arabia’s exports averaged 1.83 million bpd in the first four months of 2018, up 32 per cent from the 1.39 million bpd recorded in the same period last year. What this shows is that Saudi Arabia is already boosting exports to global markets, but in the form of refined products rather than crude.

Oil prices have fallen due the direct result of the market recalibrating to the likelihood of higher OPEC+ production in the second half of the year. A few other factors could help keep a lid on oil prices over the next year or so. The first thing that comes to mind is soaring U.S. shale supply. The U.S. has added somewhere around 800,000 bpd since the start of the year, a staggering sum. Infrastructure constraints in the Permian are real, but so far they have not slowed down output.

The U.S. inventory data showed that crude stockpiles recorded a large weekly draw on the back of strong refinery runs. EIA report revealed that crude inventories fell by 5.9 million barrels for following a decrease of 4.1 million barrels in the previous week compared to expectation for some 3.7 million barrels. Record refinery throughput led to the larger-than-expected stockpile draw with the world’s biggest oil consumer even as domestic production remains at 10.9 million barrels per day. Moreover, stocks at the Cushing terminal in Oklahoma fell 1.3 million barrels to 32.6 million barrels. Gasoline supplies were up for the fourth time in five weeks as demand weakened. The 3.3 million barrels gain against the expectation for one million barrels fall in supply level – took gasoline stockpiles up to 240 million barrels. Following last week’s addition, the stock of the most widely used petroleum product inched closer to the year-earlier level and is 6 per cent over the five-year range. Distillate fuel supplies went up 2.7 million barrels last week, again contrary to expectations for 700,000 barrels decrease in supply level. The weekly rise could be attributed to lower demand. At 117.4 million barrels, current supplies are 23 per cent below the year-ago level and 14 per cent lower than the five-year average.

The API reported a draw of 3.016 million barrels in crude oil inventories for the week ending June 15, compared to analyst expectations that this week would see a draw in crude oil inventories of 1.898 million barrels. Last week, API reported a small build of 800,000 barrels of crude oil. However, the API reported a surprise build up in gasoline inventories for week ending June 15 in the amount of 2.113 million barrels. Distillate inventories also saw a surprise build this week of 750,000 barrels, compared to an expected draw of 164,000 barrels, while inventories at the Cushing, Oklahoma site fell again this week, by 1.594 million barrels.

Meanwhile, Brent prices are going through a bigger adjustment than WTI because Brent is relatively more overpriced than WTI. The differing reaction narrowed Brent’s premium to $ 5.77 from more than $ 10 last week.

US drillers cut the number of rigs drilling for oil by one to 862, the first cut in 12 weeks. Hedge funds and money managers cut their bullish wagers on US crude futures and options to the lowest in nearly eight months as crude fell 1.4 per cent as US production soared.

We will continue to see heightened volatility next week as investors continue to digest Friday’s OPEC decision. We could see pullback into support because many investors don’t like to chase market higher, especially since they could’ve bought crude oil about 5 per cent lower earlier in the week. Uncertainty over the size of the production increase could also continue to fuel a volatile reaction. Furthermore, OPEC is not expected to actually release a hard target, but many traders expect the real figure to remain well-below the 1.8 million barrels already being removed from the market. Meanwhile, Traders are also concerned that escalating dispute between U.S. and China could hit U.S. crude oil exports to Beijing. This could leave markets prone to supply shortages and price spikes in case of large, unforeseen disruptions.

(Navneet Damani is AVP Research at Motilal Oswal Commodities)