Oil not out of the woods yet
COMMODITY prices have trended lower generally over the past quarter, and managed money positioning in the futures market has retreated to one yearlows in recent months.
Energy and metals prices have weakened for several reasons elaborated below, but we do not see current price levels as a sustainable average for the remainder of the year.
A downside risk for the entire complex revolves around China’s economic outlook and heightened Middle East tension, disruption risk in Venezuela, and a tighter sanction regime are the most bullish risks for the oil market, while continued shale outperformance would pressure energy prices downward in the balance of the year.
Recent performance of the crude oil complex suggests a massive sell off is underway.
We reckon the most viable reasoning to such action is the perception of shale oil breakeven level and stubbornly high level of inventories in OECD countries.
A souring in long term sentiment is driving prices lower.
We expect oil prices to move to the mid US$ 50 level in the summer but then fall to US$ 50 per barrel in 4Q17 and 1Q18.
Many factors, including a weak gasoline demand, the return of African supplies, a disappointing OPEC meeting, Chinese economic concerns and record high inventory levels have moved oil lower in the past couple of weeks.
The most worrisome factor on the oil market is the perception of the shale oil breakeven level.
US tight oil producers proved in the last earning season that they continue to grow production within the cash flow in US$ 50 per barrel basis and can likely grow on an even more accelerated basis at US$ 55 to US$ 60 per barrel.
If OPEC policy is a signal of where the 24- country group is going to be producing, the marginal barrel produced of the other supply will ultimately determine price.
If there is universal acceptance that tight oil output is that marginal barrel, then cost improvements showcased in 1Q earnings suggest the market must reprice the barrel even lower, thus the recent correction Despite recent selling pressure, the WTI future curve continues to flatten, global inventories are drawing and the peak summer demand season is upon us.
The expectation of a stock drawdown may already be priced in; however, history has shown that sharp changes in the relative level of inventories tends to track prices closely shown in the figure below.
For that reason, we think that further downward movements can be expected but midterm price expected to be on an upward trajectory.