Oil bulls are ‘clutching at straws’ as rally fizzles
Analysts say investors are better off looking at gasoline futures
A spirited oil rally barely extended to a fourth-consecutive day on Thursday, as Iran appeared to be cool to a Saudi-Russia proposal to freeze output.
Crude oil prices have rallied more than 14 percent since Saudi Arabia, Russia — two of the world’s largest oil producers—along with Venezuela, Iraq and Qatar, unveiled plans to maintain their production to levels reported in January, provided other major OP EC and non-OPEC producers joined in. On Thursday, U.S. crude managed to eke out a gain of just 11 cents to $30.77 US per barrel, climbing down from its peak of $31.98 US, after the producers’ meeting in Tehran yielded no change in supply outlook and traders fretted over rising U.S. inventories.
But Citibank analysts had a succinct warning about the rally: Oil bulls are “clutching at straws,” they said.
“The market clearly wants to see some signs of life in OPEC, but we think bulls (or rather producers fearful of further price falls) are likely to be better served” by focusing on the summer outlook for gasoline, Citibank analyst Seth Kleinman said in a note Thursday.
Iran’s buy-in is vital for a meaningful pact as the country is poised to bring between 500,000 to one million barrels per day of oil to the market in the next 12 months after global powers lifted sanctions on the country earlier this year.
Market speculation was that Iran would be offered a cap of 300,000 bpd above its current levels.
“That this was not enough speaks either to Iran’s confidence that it can exceed that number this year, or to the breakdown in inter-OPEC relations, or both,” Kleinman said.
Iran argues OPEC members such as Saudi Arabia and Iraq exceeded their quota to make up for Iran’s sanction-induced production decline over the past four years, and they should be the ones rolling back to make way for Iran.
“If there is a will between Saudi Arabia and Russia to control the market, it (the freeze) is going to happen,” says Sara Vakhshouri, a Washington-based analyst who once worked for the National Iranian Oil Company. “But if they are waiting for Iran, it’s not a rational decision.”
The Big Freeze pact between major producers is in itself a halfhearted attempt to manage markets, as the five countries have collectively raised their production by nearly two million bpd since the second quarter of 2014, data from the International Energy Agency shows.
The pact would have little impact on prices as the countries are freezing, not cutting, output, said Omar Al-Ubaydli, a Bahrainbased analyst.
“All the Saudis are doing is showing the world, and their internal constituents, that the rest of the world cannot be trusted and, sure enough, Iran didn’t waste any time,” said Al-Ubaydli, a senior affiliated research fellow with the Arlington-based George Mason University.
A few months from now, look for Russian President Vladimir Putin to claim he can’t control Russian oil firms as they are private companies.
“There is little history of collaboration, truth to be told,” AlUbaydli said, referring to Russia’s decision to break its pact with OPEC in 1999.
Patricia Mohr, analyst with Scotiabank, believes OPEC and Russia will probably need to cut production, even if world demand advances at a healthy 1.8 per cent clip in 2016 and U.S. production is cut modestly.
Rather than looking for meaning in O PE C’ s pronouncements, investors are better off looking at gasoline futures to get a better sense of oil’s trajectory, analysts say.
“Recent U.S. and Chinese data have dampened expectations of gasoline demand growth in 2016, amid a back-drop of negative economic sentiment, but vehicle sales growth gives some cause for continued optimism,” Kleinman noted.
A U.S. crude surge was cut short Thursday after official U.S. data showed crude inventories rose to an 86-year high of 504 million barrels, up 2.1 million barrels last week.
While OPEC’s latest effort may be a false dawn for oil, it signals the group’s intention to react to price declines, which, would likely discourage shorting of crude oil futures.
As much as 5.5 million bpd of oil is operating at negative cash margins, according to Sprott Asset Management LP, suggesting that current prices are unsustainable for many high-cost producers.
“Prices haven’t been rising because of the OPEC rumour, prices have been rising as it’s becoming more evident output will start to decrease forcibly,” Al-Ubaydli said.
An easing off the U.S. dollar, that has deflated commodity prices since mid-2014, may also be necessary for a sustainable recovery in oil.
“Relief from this (U.S. dollar) strength — perhaps triggered by a delay in further Fed funds rate hikes this year — would help to lift oil prices,” said Mohr.