Can the recent rally in crude oil continue?

GEOPOLITICAL events could keep prices elevated above US$70 Brent in April and May, but the building blocks for these higher prices are likely to collapse as the year progresses. Over the near term, however, prices continue to benefit from a perfect storm of stagnant supply, geopolitical risk, and a harsh winter, which have depleted product stock levels and brought the ‘rebalancing’ within reach.

The change in output expectations in Venezuela from 1.4 million barrels per day (mb/d) to 1.1 mb/d to 1.2 mb/d has tightened our balances, and causes a slight upward revision to our price expectations in 2Q18 and 2019.

However, in the mid term we should see the price facing a possible correction owing to stock buildup as non-OPEC countries continue to ramp up supply into the market

Heightened geopolitical risks in Venezuela and Iran, and unplanned outages in Iraq and Libya are threatening future supplies, keeping prices elevated, for now. A retaliation by the US and its allies to the chemical attack in Syria, Houthi missiles targeting Aramco’s energy facilities, and increased tension with Iran suggest this geopolitical risks would not likely subside in the near term.

Of course, any escalation in Syria may also instigate unrest elsewhere in the region, either against the US or its allies, raising the threat to the delivery of energy supplies.

So, with the driving season fast approaching and OPEC making its June meeting decision to extend all but a foregone conclusion, it is difficult to see a drastic downside to oil prices in the next two months of 2Q.

US EIA’s weekly data are likely to remain supportive for higher prices this quarter. US crude inventories are over 110 mb (21 per cent), below their level from last year and about 12 mb below the five-year average. Despite the turnaround period, a strong refining margin environment is still giving US refineries sufficient incentive to run at levels that are 1.2 mb/d higher than average.

The latest weekly data pegged US crude exports at almost 2.2 mb/d. US production continues to grow strongly, despite signs that capital discipline is underway. At about 430, the frac spread count is just shy of levels reached about four years ago, when average well productivity was only a fraction of what it is today.

Output is seen increasing by 800 kb/d by year-end, and EIA expects an even higher one mb/ d. While Midland differentials have doubled in recent months, many producers hedged and are unlikely to change their plans for this year. Hence, we should see recovery in production as we head to the second and third quarter of this year.