Last year ended on a
very sour note as the fall in oil prices that had started in June 2014 showed
no sign of easing. As a matter of fact last December prices fell to levels not
seen since 2008 and we started the New Year with talk of $20, $15 and even $10/bbl.
These bearish views seemed to be justified until the middle of January when
Brent hit a low at $27.10/bbl and WTI $26.05/bbl the following month. Since
then, however, the market has entered a correction phase and now there is a
genuine belief that this retracement will turn out to be more than just a
correction. What has happened in the first three months of the year to trigger
this change of heart?
Low oil prices are
meant to stimulate demand and cut back supply. Whilst this is certainly true
for the latter global oil demand has failed to show any signs of rising.
Year-on-year global demand growth for 2016 stood at 1.28 mbpd in December based
on the average forecasts of the EIA/IEA/OPEC. This growth has been reduced to
1.18 mbpd three months later. Absolute demand figures for this year have been
cut from 95.04 mbpd in December to 94.94 mbpd in March. Non-OPEC supply, on the
other hand, seemed to have reacted to falling prices as it has been revised
down by 680,000 bpd for this year over the last three months from 57.52 mbpd to
56.84 mbpd.
With non-OPEC supply
falling harder than demand the call on OPEC’s crude has jumped from 30.95 mbpd
at the end of last year to 31.40 mbpd in March. It is certainly a bullish
development but may not be as bullish as it seems. This is due to OPEC’s own
burgeoning output. Market share rather than balancing is in the organisation’s
priority and their production level has increased from 32.21 mbpd in December
2015 (secondary sources) to 32.47 mbpd in March (latest Reuters survey). Throw
in that Iranian sanctions were lifted on January 16 this year and the Persian
Gulf country loudly declared its intention of increasing crude oil production
and exports as fast as they physically can. This is why Iran’s production has
risen 340,000 bpd over the last three months.
Hopes have been
running high about the potential bullish impact of the planned OPEC/non-OPEC
production freeze but it is hard to see how sticking to the January output
level would be supportive for oil prices. That month OPEC produced 32.45 mbpd
(secondary sources). Maintaining this level is a tall order in itself as Iran
will almost surely not be part of any agreement but even without Iran’s
reluctance to participate this year will see a global stock build of more than
1 mbpd. There will be no re-balancing this year.
As far as developments
on the inventory front are concerned we can only rely on US data for the first
quarter of this year and this is not exactly bullish either. US total
commercials stocks have jumped by 51 million bbls since December last year to
1.356 billion bbls, a record high. Almost all of this increase has taken place
in crude oil inventories which have risen from 487 million bbls to 535 million
bbls whilst stocks at Cushing are up by 3 million bbls. Low oil prices have had
a negative impact on oil production which has fallen from 9.202 mbpd in
December 2015 to 9.022 mbpd at the end of March. It is, however, worth noting
that we are not far away from levels where it is economical for shale oil
producers to increase production.
The three most
important developments we have learnt during the first quarter of this year are
as follows:
1.) Oil prices below
$30/bbl are damaging. They undermine producers though if prices are going to
dip below this threshold once again this weakness will probably be short-lived.
2.) Oil prices around
$40/bbl are justified by the current supply/demand estimates but not higher. As
mentioned above further price strength up to the $50/bbl are basis WTI will
almost certainly trigger an increase in US production as cash-strapped
producing companies will be desperate to ramp up output. Actually, the
same is probably true for other OPEC and non-OPEC producers. The higher prices
go the bigger the temptation is to increase output regardless of the agreements
these nations are bound by.
3.) Oil prices will only
break out of this $25/bbl-$45/bbl range on the upside when the re-balancing
takes place. Re-balancing means global oil inventories depleting; in other
words global demand exceeding global supply. This will only happen in the near
future if producing nations cut rather than freeze production or let time take
its course and wait for “natural re-balancing” which will only start in the
second half of 2017 at the earliest.
The upshot saw WTI
gaining 3.51% and Brent 6.22% in 1Q 2016. Heating Oil returned 5.42% and RBOB
12.22%. These returns are, however, deceptive because including rollovers
you’ll find WTI actually losing 9.13% since the end of December and Brent
returning a mere 0.83%. Heating Oil managed to close 0.47% higher. Due to the change
in contract specification RBOB lost 8% on the quarter.
False hopes in the
stock markets
A quarterly summary
would not be complete without briefly mentioning financial developments. In a
nutshell, any gains that took place over the last three months were based on
hopes that global monetary policy would remain accommodative. The cautionary
outlook from the Fed helped lift US stocks with the DJIA gaining 1.49% and the
S&P 500 index 0.77% on the quarter. The performances of major European and
Far East indices were dismal: the FTSEurofirst 300 index lost 7.72%, the DAX
7.24%, the Nikkei 225 Index 11.95% and the Shanghai Composite Index 15.12%. As
far as the US is concerned there was some light at the end of the tunnel in
December last year when the Federal Reserve ended its unprecedented run of
seven years when it increased its benchmark federal fund rates by a quarter of
a percentage. There has, however, been no follow-through increase after a slew
of mixed US economic data cast a shadow over its recovery.
Hiking rates is
currently out of question in the eurozone or in Britain whilst the Bank of
Japan adopted negative rates in January in a desperate attempt to shore up its
ailing economy. China, the engine room of the world economy, has just seen its
credit outlook slashed from stable to negative by Standard & Poor, not
exactly a vote of confidence either. Add in the migrant crisis together with
the related terror attacks that threaten to derail whatever fragile economic
growth there is and you will agree that any stock market optimism is built on
weak foundations.