Market expectations push oil prices lower

KAMCO MARKET REPORT

Oil markets remained fragile and mostly trended lower despite the OPEC announcing extension to its existing output cut agreement. After the OPEC meeting, which extended the agreement by a further nine months until March-18, crude prices witnessed one of the biggest daily declines in several weeks, as the market was expecting deeper cuts by the producers to curb supplies. The slide in prices continued during June-17, initially due to the announcement that US would pull out of the Paris Climate deal that would possibly result in increased drilling activity in the US and higher crude supply.

The market got another shock after the EIA reported an unexpected inventory build in the US for the first time in nine weeks, casting further doubts on the effectiveness of the OPEC output cuts that is being continuously countered by rising production in the US. Moreover, the diplomatic tensions in relation to Qatar also did not have any visible impact on oil prices, as supplies are not expected to be affected.

In addition, the revival of oil output in Libya and Nigeria further threatens to offset the effectiveness of OPEC cuts. According to the latest monthly oil production data from Bloomberg, OPEC output increased by 1% or 315 tb/d during May-17 as both Nigeria and Libya pumped additional 310 tb/d during the month. Output by Saudi Arabia continued to remain below the 10 mb/d level while UAE’s decline of 40 tb/d was offset by an equivalent increase in output by Iraq.

Meanwhile, a more targeted strategy by Saudi Arabia in reducing oil supply to the US and limiting supplies to some Asian buyers is expected to have a positive impact on the oil market. According to Reuters, the Kingdom would reduce July-17 crude allocations to Asia to about 0.3mb/d, less than the level in June-17, while allocations to the US is expected to be curbed by almost 35%. This comes after China’s monthly oil imports reached the second highest level on record in May-17 after increasing by almost 15.4% year-on-year taking advantage of the low oil prices. That said, purchases in June-17 is expected to be lower; however, July-17 which is a peak demand season for oil demand in China, should once again trigger higher imports.

Near term trend in oil prices is expected to be stable as estimates suggest crude inventory drawdown in the US in the coming weeks. OPEC also expects higher demand for crude during 2H-17 on the back of largely improving economic fundamentals globally. According to the latest OPEC monthly report, global oil demand is expected to increase by close to 2 mb/d during 2H-17 while non-OEPC supply is expected to increase by 0.5 mb/d. The higher expected consumption would be backed by demand for higher transportation fuel in the US as well as rising oil consumption in India. Moreover, KAMCO Research expects higher domestic demand from GCC OPEC members due to seasonal summer consumption. This would further limit exports from the region and support prices in the near term.

Oil prices

Oil traded mostly below USD 50/b during May-17 and slowly started crawling up closer to the date of the OPEC meet on expectations that producers would not only renew the pact but also undertake deeper cuts. In the meeting, the producers did renew the agreement and in fact extended it by nine months as against the expectations of six months but did not impose deeper cuts on the members. This resulted in a steep decline in oil prices following the announcement as seen from the 5% fall in OPEC and Brent crude for the next two trading sessions.

The market suffered further in June-17 when the US pulled out of the Paris climate deal prompting higher drilling in the US. A surprise inventory build in the US also pushed prices further down to the lowest in more than six months for OPEC crude that reached USD 45.48/b on 9-June-17. According to the EIA report, US stockpiles increased for the first time in nine weeks with crude inventories swelling by 3.3 million barrels as against expectations of an equivalent drawdown during the week.

In the US, rig count continued to rise unabated increasing 21 weeks consecutively to reach 741 for the week ended 9-June-17. In addition, there are no near term catalysts that would see any slowdown in the number of rigs being drilled in the US. According to Rystad Energy, there is a significant number of drilled but uncompleted wells in the US that are commercially viable to put into operation even at oil price of as low as USD 40/b or USD 30/b.

However, more rigs may not necessarily mean more oil in the market. According to an EIA report, although the rig count has been increasing in the Permian Basin, the productivity of the newly drilled wells have been falling every month since September-16, as against prior expectation of seeing a first decline this month. EIA’s estimate in its latest monthly Drilling Productivity Report says that the average amount of oil produced per well in the Permian Basin is expected to fall to just 602 barrels a day in July-17, down from a peak of 704 barrels a day in August-16.

World Oil Demand

World oil demand growth estimates for 2016 remained unchanged in the latest monthly oil market report from OPEC and is expected to grow by 1.44 mb/d to average 95.12 mb/d. Demand expectations for 2017 was also kept unchanged at 96.38mb/d, an increase of 1.27 mb/d as compared to 2016 despite some adjustments to demand data within the OECD region. Demand estimates for OECD America was revised lower by 50 tb/d for Q1-17, reflecting the slower-than-anticipated oil demand growth in Canada and Mexico. This was offset by an upward revision to US oil demand by almost 28 tb/d in Q1-17 to account for higher distillate oil and jet fuel demand during March-17 on the back of higher industrial production. The month saw the biggest monthly increase so far this year amounting to 0.4 mb/d or 2.4% month-on-month growth, despite disappointing data for gasoline demand that declined for the third consecutive month due to factors related to transportation sector, including a drop in vehicle sales and higher retail fuel prices that led to a decline in miles driven.

Meanwhile, oil demand data for OECD Europe for April-17 also showed weak momentum for the third consecutive month due to slower-than-expected industrial activity in Germany, UK and Turkey, in addition to slowerthan-anticipated oil demand growth in the Netherlands and Belgium. The softer trends largely reflect the high baseline effect for the overall OECD Europe oil demand performance.

Oil demand in the Big 4, according to preliminary data for April-17, indicated a steep year-on-year decline in oil requirements for all product categories. Jet/kerosene and fuel oil requirements witnessed the biggest declines due to lower activity in UK’s aviation sector and slow demand for bunkering, especially in France.