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Oil price being kept in check?

By Ian Woodcock

The familiar fragility of oil prices has been tested by a number of factors in recent weeks, after three months of relative stability.

WTI oil prices dropped more than 10% in March, prompted by persistently high US inventories and confusion related to Saudi Arabia’s February production levels. Prices rebounded in late March and early April on signs of inventory draws, as well as more constructive headlines regarding the upcoming OPEC meeting and rising geopolitical tensions in the Middle East.

This price volatility has brought home to investors the fragility of global oil markets. Optimistic analysts were estimating 2017 prices could reach as high as $70USD a barrel at the start of the year, yet the recent slump has left many wondering if worse is still to come. Below I look at the four factors likely to continue influencing oil prices in coming months.

Inventory levels

Despite OPEC production cuts, crude inventories in OECD countries remain high, particularly in the US, where high imports and refinery maintenance have contributed to an increase. In the next few months, declining shipments from the Arabian Gulf, the end of the refinery maintenance period and the beginning of the summer driving season are expected to drive US inventory levels lower. While data over the last few weeks points to inventory draws, the US Energy Information Administration revealed inventories remain near the upper limit of the average for this time of the year.

OPEC production cut

The next OPEC meeting takes place on May 25, and a decision will be made on whether to extend production cuts. OPEC’s decision to cut production by 1.2m barrels a day last November, in order to reduce crude inventories, was arguably the main driver of the oil price rally and subsequent stability over the last few months.
While headlines seemingly vary on a daily basis, recent commentary indicates OPEC is inclined to extend the cuts. Saudi Arabia – OPEC’s biggest producer and the world’s top exporter of oil – reportedly told the cartel it wants to extend the agreement. However, Saudi Arabia has previously made it clear it will not ‘bear the burden of the free riders’ – a likely message to US shale. A rolling over of the OPEC agreement will provide support to oil prices, but any doubts could potentially result in a correction.

US shale rebound

Positive global oil sentiment since the end of last year, driven by larger-than-expected OPEC production cuts, has encouraged US producers to get back to work. Capital expenditures are expected to increase approximately 30% year-on-year. While capex remains at half of the industry high in 2014, improved shale productivity is enabling producers to break even at $45 a barrel. This, along with a rapidly-rising rig count and incomplete well inventory, points to US production growth in 2017 – estimated at between 0.2m and 0.9m barrels per day.
Should production exceed the higher end of this range, it is likely to offset more than half of the combined circa 1.8m barrel cutback by OPEC and others, including Russia. This could put pressure on oil prices in the second half of 2017.

Robust demand
In addition to the supply-related factors above, demand appears resilient. With the world economy expected to grow at 3.2% in 2017, the International Energy Agency forecasts global demand to rise by 1.3m to about 97.9m barrels a day. However, this is 0.1m lower than the prior forecast, due to lower-than-previously-expected growth in countries including Russia, Korea and the US, as well as the Middle East. In the meantime, supply is expected to grow by 0.5m barrels a day, averaging 97.5m, assuming US supply growth of 0.7m barrels a day.
All of this suggests the delicate balancing process remains intact, keeping oil prices’ range bound and with less possibility for sudden spikes or falls. The early year enthusiasm should now have been curbed, with a ‘lower for longer’ expectation for global oil prices being more commonplace at present. As always, markets are susceptible to change, and investors will no doubt be keeping a close eye on events in the Gulf peninsula, Russia, China and Korea, as well as the factors above. However, for now at least, the price range would seem to be stable.

The writer is investment consultant at Chase Buchanan: ian.woodcock@chasebuchanan.com

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