Crude looks tentative on new perch in mid-$40s

Economy May 07, 2016 01:00


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CRUDE-OIL FUTURES touched year-to-date highs in April and held on to most of their gains entering May, despite major producers inside and outside the Organisation of the Petroleum Exporting Countries (Opec) gathered in Doha on April 17 failing to agree on

An open-ended oil workers’ strike in Kuwait, the start of which coincided with the Doha meeting, slashed that country’s crude-oil output by 60 per cent to around 1.1 million barrels per day (MMbpd), reminding the markets that producers across the Middle East and North Africa remain particularly vulnerable to supply disruptions, due either to sabotage, or terrorist activity, or general unrest.

The Kuwaiti strike was in response to a raft of financial and economic reforms proposed by the government in March to cope with low oil prices, including oil-sector wage cuts. The strike was the first at a national oil company in the Gulf region since 2011, but can hardly be expected to be the last, given that governments across the region are tightening their fiscal belts.

The Kuwait strike ended after three days, but it set crude on an upward trajectory, which saw Brent vault over US$48 a barrel on April 28 to a year-to-date high settle.

Supply disruptions continue to plague Nigeria, while growing financial distress among producers such as Venezuela and Angola is shaping the view that involuntary output reductions may be coming down the pike for some of the Opec producers who are starting to run out of money to pay their joint-venture partners and oilfield service providers.

US crude-oil production continues to slide. It slipped below the 9MMbpd million mark in April, and is on course to average 8.6MMbpd in 2016, according to the latest projections by the US Energy Information Administration, down around 800,000bpd from last year. The EIA also lowered its 2017 output forecast to 8MMbpd.

Hedge funds and money managers on both sides of the Atlantic built major net long positions in the NYMEX light sweet and ICE Brent contracts through April, presumably buying into the narrative of steady global demand growth and declining non-Opec production rebalancing markets in the second half of this year.

The US Federal Reserve decided to hold interest rates steady at its April 27-28 meeting, which, though widely expected, weakened the greenback, also giving a leg up to crude-oil prices. Several market watchers, nevertheless, remain unconvinced by crude’s latest rally.

The continued slide in US oil-rig count, now down 80 per cent from its October 2014 peak, is no longer a surprise, and the first annual drop in crude output in 2016 after seven consecutive years of gains has long been baked into market fundamentals.

Iran ratcheted up its crude-oil production to 3.23MMbpd in March, according to S&P Global Platts data, 340,000bpd higher than December, the last full month before the lifting of sanctions against the country over its nuclear programme. Opec’s March production inched up from February, and preliminary data showed a modest climb in April exports.

Saudi Arabia scuttling a production-freeze agreement in Doha because of Iran’s refusal to participate points to a likely roll-over of Opec’s market-share strategy at its next scheduled meeting on June 2.

In the absence of any further major supply disruptions in the Middle East/North Africa region, and with Iran pulling out all the stops to ramp up, even if that happens to be slower than suggested by official rhetoric, it’s hard to see what exactly is accelerating the market towards a rebalancing in the second half of this year. The International Energy Agency expects world oil demand to rise by 1.2MMbpd in 2016, with Asia-Pacific contributing a robust 900,000bpd.

Hopes are pinned on India displacing China as the new driver of demand growth in Asia. India is rising, no doubt, but from a relatively smaller consumption base of around 4.2MMbpd. Even with anticipated 8-per-cent annual growth, the country will add barely 340,000bpd to oil demand.

Meanwhile, Chinese oil-demand growth is slowing from 5.7 per cent in 2015 to an expected 2 per cent in 2016 on a base of just over 11MMbpd. This slashes nearly 400,000bpd of incremental consumption, leaving it to add a paltry 220,000bpd this year.

Demand in Asia’s second-largest oil consumer Japan is in secular decline. In South Korea, the region’s fourth-largest consumer, it grew by a healthy 5.9 per cent in the first quarter of this year on the back of low prices, which adds about 110,000bpd. Even disregarding the downside risk to expected rates of demand increase in Asia’s major consumers, the numbers don’t add up.

The bottom line is that the current oil-market downturn is destined for a mainly supply-driven and hence painfully slow rebalancing, given that the demand response is being weakened by economic headwinds in the short term and a push towards cleaner energy in the longer term.

The industry’s math is being rewritten, from the cost of the marginal barrel, to the price elasticity of demand. The magic moment may not come in the second half of 2016. If it does, it may not endure.

Vandana Hari is Asia editorial director, S&P Global Platts, and research scholar, S&P Global Institute.