Grappling with volatility in a barmy crude market

The oil market is not making a whole lot of sense at present to a whole lot of people; the Oilholic is admittedly one of them. However, wherever you apportion the blame for the current market volatility, do not take the convenient route of laying it all at China’s doorstep. That would be oversimplification!

It is safe to say this blogger hasn’t seen anything quite as barmy over the last decade, not even during the post Lehman Brothers kerfuffle as a US financial crisis morphed into a global one. That was in the main a crisis of demand, what’s afoot is one triggered first and foremost by oversupply. 

As one noted in a recent Forbes column, the oversupply situation – not just for oil but a whole host of commodities – merits a deeper examination. The week before we saw oil benchmarks plummet after the so-called ‘Black Monday’ (August 24) only for it recover by Friday and end higher on a week-over-week basis compared to the previous week’s close (see graph above, click to enlarge)

This was followed on Monday, August 31 by some hefty gains of over 8% for both Brent and WTI. Yet at the time of writing this blog post some 48 hours later, Brent had shed over 10% and the WTI over 7% on Tuesday but again gained 1.72% and 1.39% respectively on Wednesday.

The reasons for driving prices down were about as fickle as they were for driving them up and subsequently pulling them down again, and so it goes. When the US Energy Information Administration (EIA) reported on Monday that the country’s oil production peaked at just above 9.6 million barrels per day (bpd) in April, before falling by more than 300,000 bpd over the following two months; those in favour of short-calling saw a window to really go for it.

They also drew in some vague OPEC comment (about wanting to support the price in tandem with other producers), knowing full well that the phoney rally would correct. The very next day, as the official purchasing managers’ index for Chinese manufacturing activity fell to 49.7 in August, from the previous month’s reading of 50, some serious profit-taking began.

As a figure below 50 signals a contraction, while a level above that indicates expansion, traders found the perfect pretext to drive the price lower. Calling the price higher based on back-dated US data on lower production in a heavily oversupplied market is about as valid as driving the price lower based on China’s manufacturing PMI data indicative of a minor contraction in activity. The Oilholic reckons it wasn’t about either but nervous markets and naked opportunism; bywords of an oversupplied market.

So at the risk of sounding like a broken record, this blogger again points out – oversupply to the tune of 1.1-1.3 million bpd has not altered. China’s import level has largely averaged 7 million bpd for much of the year so far, except May. 

Yours truly is still sticking to the line of an end of year Brent price of $60 per barrel with a gradual supply correction on the cards over the remaining months of 2015 with an upside risk. Chances of Iran imminently flooding the market are about as likely as US shale oil witnessing a dramatic decline to an extent some in OPEC continue to dream off.

But to get an outside perspective, analysts at HSBC also agree it may take some time for the market to rebalance fully. “The current price levels look completely unsustainable to us and a combination of OPEC economics and marginal costs of production point to longer-term prices being significantly higher,” they wrote in a note to clients.

The bank is now assuming a Brent average of $55.4 per barrel in 2015, rising to $60 in 2016 and $70-80 for 2017/18. Barclays and Deutsche Bank analysts also have broadly similar forecasts, as does Moody’s for its ratings purposes.

The ratings agency sees a target price of $75 achieved by the turn of the decade, but for yours truly that moment is bound to arrive sooner. In the meantime, make daily calls based on the newsflow in this barmy market. That’s all for the moment folks! Keep reading, keep it crude!

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© Gaurav Sharma 2015. Graph: Oil benchmark Friday closes, Jan 2 to Aug 28, 2015 © Gaurav Sharma, August 2015.

Buyers' market & an overdue oil price correction

Recent correction in the price of crude oil should come as no surprise. The Brent front month futures contract fell to a 26-month low last week lurking around the US$98 per barrel level.

The Oilholic has said so before, and he’ll say it again – there is plenty of the crude stuff around to mitigate geopolitical spikes. When that happens, and it has been something of a rarity over the last few years, the froth dissipates. In wake of Brent dipping below three figures, a multitude of commentators took to the airwaves attributing it to lower OECD demand (nothing new), lacklustre economic activity in China (been that way for a while), supply glut (not new either), refinery maintenance (it is that time of the year), Scottish Referendum (eh, what?) – take your pick.

Yet nothing’s changed on risk front, as geopolitical mishaps – Libya, Sudan, Iraq and Ebola virus hitting West African exploration – are all still in the background. What has actually gotten rid of the froth is a realisation by those trading paper or virtual contracts that the only way is not long!

It’s prudent to mention that the Oilholic doesn’t always advocate going short. But one has consistently being doing so since late May predicated on the belief of industry contacts, who use solver models to a tee, to actually buy physical crude oil, rather than place bets on a screen. Most of their comparisons factor in at least three sellers, if not more.

Nothing they've indicated in the last (nearly) five months has suggested that buyers are tense about procuring crude oil within what most physical traders consider to be a "fair value" spot trade, reflecting market conditions. For what it’s worth, with the US buying less, crude oil exporters have had to rework their selling strategies and find other clients in Asia, as one explained in a Forbes post earlier this month.

It remains a buyers’ market where you have two major importers, the US and China who are buying less, albeit for different reasons. In short, and going short on crude oil, what’s afoot is mirroring physical market reality which paper traders delayed over much of the second quarter of this year from taking hold. Furthermore, as oversupply has trumped Brent’s risk premium, WTI is finding support courtesy the internal American dynamic of higher refinery runs and a reduction of the Cushing, Oklahoma glut. End result means a lower Brent premium to the WTI. 

However, being pragmatic, Brent’s current slump won’t be sustained until the end of the year. For starters, OPEC is coming to the realisation that it may have to cut production. Secretary General Adalla Salem El-Badri has recently hinted at this.

While OPEC heavyweight Saudi Arabia is reasonably comfortable above a $85 price floor, hawks such as Iran and Venezuela aren’t. Secondly, economic activity is likely to pick up both within and outside the OECD in fits and starts. While Chinese economic data continues to give mixed signals, India is seeing a mini-bounce. 

Additionally, as analysts at Deutsche Bank noted, “With refineries likely to run hard after the maintenance period, this will support crude oil demand and eventually prompt crude prices, in our view. This may be one of the factors that could help to eliminate contango in the Brent crude oil term structure.”

While the general mood in the wider commodities market remains bearish, it should improve over the remainder of the year unless China, India and the US collectively post dire economic activity, something that’s hard to see at this point. The Oilholic is sticking to his Q1 forecast of a Brent price in the range of $90 to $105 for 2014, and for its premium to WTI coming down to $5.

Meanwhile, Moody's has lowered the Brent crude price assumptions it uses for ratings purposes to $90 per barrel through 2015, a $5 drop from the ratings agency's previous assumptions for 2015. It also reduced price assumptions for WTI crude to $85 per barrel from $90 through 2015.

The agency’s price assumptions for 2016 and thereafter are $90 per barrel for Brent crude and $85 for WTI crude, unchanged from previous assumptions. Moody’s continue to view Brent as a common proxy for oil prices on the world market, and WTI for North American crude.

On a closing note, here’s the Oilholic’s second take for Forbes on the role of China as a refining superpower. Recent events have meant that their refining party is taking a breather, but it’s by no means over. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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To email: gaurav.sharma@oilholicssynonymous.com

© Gaurav Sharma 2014. Photo: Russian Oil Extraction Facility © Lukoil. Graph: Brent curve structure, September 19, 2014 © Deutsche Bank