Prices hold $45-50 range despite Brexit

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As June closed, oil prices posted their sixth consecutive monthly increase. As of June 30, ICE Brent, the international benchmark, was trading at slightly below $50 per barrel (bbl), while NYMEX West Texas Intermediate (WTI), the US crude marker, was ranging just under at $49.8/bbl. Brent finished the month at $49.5 pb, and averaged $49.9 pb.

The uptick in prices comes as welcome relief to markets battered by the fallout from the UK’s decision to exit the European Union on 23 June. In the days that followed the Brexit referendum, Brent fell by as much as 7.5 percent to $47.16 — its lowest level since May 10. Oil, like other commodities and international equities, had been caught up in the ‘flight from risk’ that followed the results of the referendum. Investors, worried that Brexit would not only push the UK into recession but lead to a slowdown in global growth, have sought refuge in perceived safe haven assets, especially gold and US treasuries. The resulting rise in the US dollar also put pressure on oil prices. However, markets seemed to regain composure within days.

Nevertheless, it would seem that markets have reverted back to fundamentals, and here the story is very much one of demand catching up with the supply. A spate of supply outages in Nigeria, Venezuela and Canada, the latter due to wildfires, coupled with continuing declines in US shale output have accelerated the unwinding of the 2-year old supply glut.

The International Energy Agency (IEA) estimates that non-OPEC supply, of which the US has been the largest source of growth in recent years, is expected to contract by -0.9 mb/d in 2016. This is a significant fall from last year’s increase of 1.5 mb/d. US oil production is down -10 percent year-on-year (y/y) at 8.62 mb/d, according to weekly data provided by the US Energy Information Administration (EIA).

Oil demand has also firmed, led by rising gasoline usage in the US and strong gasoil/diesel demand in India. The IEA has just revised its forecast for global oil demand growth this year upwards by 100,000 b/d to 1.3 mb/d to reflect the improvement in demand.

OPEC production fell marginally in May, by 104,000 b/d to 32.4 mb/d, according to OPEC secondary source data. This was the sixth month in a row that output topped 32 mb/d. OPEC output was driven lower by declines in Libya, Iraq, Venezuela and Nigeria which offset gains in Kuwait, Saudi Arabia, Iran and the UAE.

Nigeria’s oil production of 1.4 mb/d is at its lowest in nearly thirty years, falling by a sizeable 251,000 b/d in May, as militants stepped up their attacks on the country’s oil wells and pipelines, sparking “force majeure” on four key export streams and disrupting production for the third straight month. With the economy on the brink of recession and attacks by the militant group the Niger Delta Avengers (NDA) growing more sophisticated, the Nigerian President Muhammadu Buhari has been forced to pacify the rebels with extensions of an amnesty offered to them in 2009 and demilitarization of the Delta area. The rebels, for their part, are demanding a greater share of Nigeria’s oil wealth.

In Iraq, power outages at the southern Basra terminal brought down oil production by 61,000 b/d to 4.3 mb/d. Iraq was OPEC’s largest source of growth in 2015, with an average increase of 673,000 b/d, but payment delays to international oil companies amid the costly war against the so called Islamic State (IS) threatens to cap, if not reduce, the country’s output in 2017.

In contrast, May saw Kuwaiti output rebound following the strike by oil workers the previous month. Production increased by 93,000 b/d to 2.7 mb/d. In the UAE, output rose by 73,000 b/d to 2.8 mb/d after maintenance work was completed on the Murban complex. Saudi Arabian production edged up by 84,000 b/d in response to higher domestic demand; further gains in Saudi crude production are expected with the onset off the summer season, when energy consumption reaches its annual peak.

Iran, meanwhile, continued to ramp up its oil output in a bid to reclaim lost market share. Production reached 3.5 mb/d in May, a rise of 89,000 b/d on April and a cumulative 675,000 b/d since the start of the year, when international sanctions were lifted.

While it is clear that the oil market is in the process of rebalancing, it should not be forgotten that at some point the crude that has been shut-in, in places like Nigeria and Libya, will be free to flow back on to international markets. Furthermore, judging by the return of twenty, previously idle, US shale drilling rigs in June, it would seem that, with oil prices in the $45-50/bbl range, a price point has been reached at which production in certain US shale plays has become more cost effective. Additional crude volumes are therefore expected to put the brakes on future oil price surges or at least slow their recent advance.

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