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Saturday , February 22 2020

Crude rallies in May on supply cuts – Outlook for non-OPEC supply growth in 2016 lowered

Bullish sentiment propelled oil prices to their fifth consecutive monthly gain in May.

Oil prices continued their bull run in May, closing higher for the fifth month in succession. Brent crude, the international benchmark, closed at $49.6 per barrel (bbl), up 3 percent month-on-month (m/m). Brent actually breached $50 during intraday trading on May 26 for the first time since November 2015. Since falling to 13-year lows of around $27/bbl in mid-January, Brent has surged by almost 80 percent. West Texas Intermediate (WTI), the US crude marker, closed in May up 7 percent m/m at $49.1/bbl. The more pronounced uptick in the price of WTI also reflected continuing declines in US shale output; indeed, the Brent-WTI spread, the difference between the prices of the two crude markers, narrowed to less than a dollar for most of May.

Driving oil’s rise has been a spate of unplanned supply disruptions, notably in Nigeria, Venezuela and, more recently, Canada. Along with continuing declines in US shale output, the global supply glut is easing and the market is moving closer to balance. Attacks by militants on pipelines in the Niger Delta took more than 10 percent off of Nigeria’s oil output, or 200,000 barrels per day (b/d), while in Venezuela, continuing power shortages have caused output to drop by more than 100,000 b/d. All the while, wildfires at Fort McMurray in Alberta in May, the heart of Canadian oil sands production, shut in 1.2 mb/d of Canada’s oil production.

Reflecting the improvement in fundamentals, in the futures markets, bullish bets on Brent forward contracts soared to record levels; the number of unhedged long positions rose to more than 400,000 contracts, a historic high, according to the International Commodities Exchange (ICE). Sentiment was buoyed by the estimations of noted bear Goldman Sachs, which announced in mid-May that the oil surplus had flipped into a deficit much quicker than anticipated, as a result of strong demand and sharp falls in supply. Oil prices jumped more than 1 percent on Goldman’s statement. Looking 12 months ahead, the forward price of Brent is currently ranging around $52.5/bbl, almost two and a half dollars higher than its 12-month (M12) forward position at the end of April.

The International Energy Agency (IEA) has shaven a further 0.1 mb/d off its outlook for non-OPEC supply growth in 2016, as a result of the unplanned outages in April and May, including the wildfires in Canada. Non-OPEC supply is now expected to fall by -0.8 mb/d from last year to 56.8 mb/d. Indeed, global supplies have fallen for two consecutive quarters this year and supply growth actually contracted on an annual basis by -0.2 mb/d in 2Q16. The IEA’s non-OPEC growth estimate also takes into account declining US crude production. This has contracted by -8.4 percent on an annual basis to 8.8 mb/d, according to the US Energy Information Administration’s estimate for the week ending May 20.

In contrast, global demand is forecast to rise by 1.2 mb/d to an average of 95.9 mb/d this year. Figures for 1Q16 show firming demand in India, China and the US, with increased gasoline and diesel use in particular provider much of the impetus.

OPEC production increased to 32.4 mb/d in April, its highest level since 2008 and the fifth consecutive month of topping 32 mb/d, according to OPEC secondary source data. Increasing supplies from Iran, Iraq and the UAE helped to offset losses in Nigeria and Kuwait which were due to pipeline sabotage and a strike by oil workers, respectively.

April saw Iranian output reach 3.4 mb/d, rising by 200,000 b/d from March. Iran’s production has increased by a cumulative 564,000 b/d in 2016. By some measures, the country has already restored output to its pre-sanctions level. Reaching its production capacity target of 4 mb/d, a level last attained prior to the financial crisis, however, is not likely without considerable investment.

Production in Saudi Arabia, meanwhile, held steady at around 10.2 mb/d although this is expected to rise ahead of the energy-intensive summer season. The collapse of the Doha talks in April to cap output has left markets anticipating OPEC members opening the taps much more freely as they bid to capture market share. This prospect is all the more likely in view of the ‘business as usual’ approach taken by oil producers at OPEC’s biannual meeting in Vienna last week, and later confirmed with OPEC’s “no change” decision at its June 2 regular meeting.

There had been talk ahead of the meeting that Saudi Arabia, fresh with its new oil minister Khaled Al-Falih at the helm, would try to mobilize other producers to reinstate the group’s official production ceiling which had been scrapped in December 2015. This is apparently in an effort to smooth over the group’s internal divisions and restore some of OPEC’s credibility and relevance. A figure of 32 mb/d was suggested, which would put it below current output. OPEC producers have a history of producing above their quotas (or above the group’s official target), so any ceiling would have been loose at best. And anyway, for any proposal to stick would require Iran’s buy-in, and this seems unlikely given the country’s plan to keep on ramping up output until it reaches its target. So for now OPEC is staying with current policy, and is content to see oil prices firm up on gradually just on tighter market conditions.

By National Bank of Kuwait


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