Rising US supply a big overhang on crude prices



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Oil prices saw the much-needed correction last week as markets finally took note of rising US production. WTI prices declined almost 10 per cent and Brent nearly 8 per cent as US production notched a record 10.25 mbpd last week.

The risk-on mood in global markets and a weaker dollar added fuel to the rally in January, but the turmoil in global markets last week also led to liquidation in oil where speculative positions were at record highs. Looking ahead, we have already seen some shakeout in excessive long positions last week and further liquidations could be seen in coming days if global risk sentiment remains weak. The current selloff has also established the fact that $65 for WTI and $70 for Brent remains a strong cap.

The correction in oil prices was due for the last few weeks, given that the last leg of the rally in January was not backed by fundamentals. A weaker dollar and surging equity markets globally helped. The fact that speculative length was already at a record high made oil prices further vulnerable for a selloff.

Reality sank in last week with new data suggesting that non-OPEC output, especially from the US, is rising at a much faster pace. The EIA monthly report suggested a revision in US November output to above 10 mbpd. The weekly data last week suggested that output crossed 10.25 mbpd, the highest since 1970.

The EIA now projects US production to touch 10.6 mbpd this year and this could offset the OPEC cuts to a large extent. Both the OPEC and the IEA (International Energy Agency) also forecast non-OPEC production to rise next year, with US contributing the most. The OPEC sees non-OPEC production rising by 1.15 mbpd next year while IEA sees a growth of 1.70 mbpd. The IEA sees US output at 10.40 mbpd in 2018. This, we believe, will remain the biggest headwind to prices despite reduced supply from the OPEC.

The steep drawdown in US inventories over the last several weeks also underpinned strength in WTI to an extent. The inventory uptick in the last two weeks, therefore, acted as another negative trigger to price. US oil stocks rose by 1.9 million barrels last week. Gasoline stocks rose by 3.4 million barrels and distillate stocks by 3.9 million barrels. US oil inventories are now 17 per cent lower compared to the same period last year.

The rally in prices has also been aided by the fact that output cuts by the OPEC may extend beyond 2018. The OPEC review meeting in January suggested that output cuts in some form may remain beyond 2018 although the exact modalities need to be worked out. OPEC output continues to be lower in y-o-y comparisons and compliance is improving.

Estimates suggest that OPEC oil output was largely unchanged at 32.5 mbpd in January and overall compliance touched 138 per cent. The drop in Venezuela’s oil output due to its existing crisis has been the biggest reason for the improvement in compliance. Iraq’s output from its northern region also remains affected ever since the Iraqi army took control from Kurds and has helped Iraq’s compliance to show up better. Libyan production dropped by 30,000 bpd due to pipeline damage while Nigeria saw production increase.

The monthly report from the OPEC this week will provide further cues about OPEC output.

On the demand side, Chinese imports touched a record 9.57 mbpd in January, nearly 0.4 mbpd higher than the record set in March 2017. Independent refiners in China received quotas that were 55 per cent higher than last year’s, so imports could be higher in coming months as well. At the beginning of this year, the IEA kept its oil demand growth estimate for 2018 unchanged at 1.3 million bpd, down from 1.6 million bpd in 2017. The OPEC pegged demand growth at a healthier 1.5 mbpd in 2018. On the whole, stronger demand has been a basic premise in all forecasts for 2018 and any demand shock could therefore derail the price rally.

On balance, while the medium to long term trend still remains positive, oil prices could see further correction in the near term, given that key technical levels have been breached and speculative positions still remain elevated. If we see another bout of risk aversion in global markets, prices could fall further before forming a stable floor. Technically, short-term bias for oil looks negative as long as it holds below Rs 3,950 and the current decline could extend towards Rs 3,770-3,740 zone. However, Rs 3,740 is likely to provide an immediate floor to the price and buying could resume later on.

Source: THE ECONOMIC TIMES