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Edward Bell - Commodity Analyst
Published Date: 27 January 2019
Crude oil futures declined last week, their first weekly loss in 2019 after three consecutive gains. Brent futures fell 1.69% to close the week at USD 61.64/b while WTI was marginally down (-0.2%) at USD 53.69/b. Both contracts managed to gain in the final day of trading as the political crisis in Venezuela escalated and pressure on the Maduro government increases. There is as of yet no apparent direct impact on flows of crude out of Venezuela; production there had fallen so precipitously in the past two years that markets have been pricing in steady declines in output so the increased political risk is having only a limited impact.
Forward curves lost some strength last week. The 1-2 month spread in Brent futures ended the week in a backwardation of just USD 0.05/b having started the week closer to USD 0.2/b in backwardation. The Venezuela news helped to compress the contango in the WTI curve though; the 1-2 month spread closed at USD 0.29/b after having dipped to USD 0.44/b mid-week. Longer-dated spreads also weakened; the Dec 18/19 spreads in both WTI and Brent are in backwardation but they fell over the course of last week.
US inventory data was delayed by a day thanks to a public holiday in the US. Total crude stocks rose by nearly 8m bbl, their largest weekly gain since November 2018 and first build in 2019. Inventories had been converging on the rolling five-year average of around 435m bbl but last week’s build helped push them in the opposite direction. Total petroleum (crude and products) stocks rose by 6.7m bbl as large builds in gasoline and crude were tempered by a seasonal draw in propane. Stocks in Singapore also pushed higher thanks to persistently high inventories of light products.
US exploration and production companies added 10 rigs last week, partially reversing the previous week’s steep decline. The rig count remains steady at around 860 rigs. The EIA published its drilling productivity report last week and expects shale basin production to increase by 63k b/d month on month in February. On an annual basis, however, the gains in output are more striking. Shale basin production will be up 1.5m b/d y/y in February and the annual gains have been at an average of 1.48m b/d in the past 12 months. The most recent production data estimated total output of 11.9m b/d, up more than 2m b/d y/y as of mid-January. The relentless increase in US crude production will be far faster in H1 than the final six months of the year and with pipelines only coming into operation in the later months of 2019 more stockbuilds will be on the cards.
Refining margins remain under pressure, particularly for gasoline. Singapore gasoline cracks off Brent fell to negative USD 2/b last week as the glut of gasoline in Asian markets weighs on margins. European gasoline cracks are also negative while US margins have fallen to barely more than USD 5/b compared with a 2018 peak of almost USD 25/b. The weak margins are a distressing signal for oil demand growth and excess availability of light crudes, optimally suited for producing gasoline.
Source: EIKON, Emirates NBD Research.
Oil market indicators are sending conflicting messages on whether conditions are actually tight or loose. Sentiment on crude markets shifted rapidly from December’s doldrums to start the new year positively; up 12% since the start of January for Brent and more than 15% in WTI. But are the gains supported by a fundamental picture of a tightening market or are they at risk of being unwound once a more detailed assessment of conditions appears?
OPEC’s production cuts are the primary factor that will contribute to tighter crude markets this year. The cuts took effect at the start of January but market estimates on how much producers have actually cut won’t be available until the end of the month. OPEC producers are meant to cut a total of 812k b/d, the bulk of which will be accounted for by Saudi Arabia. Over the weekend Saudi Arabia’s energy minister said the Kingdom would cut “significantly” above its target, similar to its performance in most of 2017. Conversely, Iraq’s exports are holding close to the record level it reached in December of 3.63m b/d. How well OPEC adheres to its current round of cuts will be a major determinant in how much markets actually tighten.
Until data on the scale of production cuts becomes available, time spreads, particularly from the physical market, can provide our best clues on how effective the cuts have been. Time spreads in the Dubai market (1-3 months) have moved to a backwardation of around USD 0.4/b in the past week, up from a contango of USD 0.3/b at the end of last year. Time spreads in Dubai hit a 2018 peak of around USD 1.40/b in backwardation in September, just ahead of the plummet in spot crude prices.
Source: EIKON, Emirates NBD Research
Brent futures have also moved tentatively into backwardation after dipping into a contango structure for most of Q4 2018. Backwardated time spreads encourage investors to take long positions in futures strategies but so far positioning in Brent remains tentative. Speculative net length in Brent has risen since the start of the year thanks to some sizeable closures of short positions (more than 23k short positions were closed last week). As a share of open interest, though, net length represented just 6.5% last week, leaving the market open for considerable more investment should investors grow more confident on the outlook for crude (WTI commitment of trader data has been delayed thanks to the US government shutdown).
While the OPEC production cuts represent a macro tightening story for the oil market, other indicators are pointing in the opposite direction. Inventory figures in particular highlight a market that is considerably looser than it had been for most of 2018. Across the major trading and reporting hubs of the US, northwest Europe and Singapore product inventories have steadily been trending higher, led principally by large builds in gasoline stocks. In the US total product inventories are more than 30.6m bbl higher than they were a year ago (and up more than 64m bbl when including crude). While the percentage change is not particularly large across any of the hubs, we argue the direction of travel is more significant. In the US and Singapore inventories are on the rise while the ARA data represents the best case for bulls as inventories are “only” flat year on year. For most of last year, by comparison, stocks were drawing down as demand conditions held steady and, in the first half of the year at least, OPEC cuts helped to drain inventories.
Source: EIKON, Emirates NBD Research
Related to the increase in inventories is the steady downward move in refining margins. Across all major refining centres margins are weakening or are substantially softer than year ago levels.
Weak refining margins are a reflection of both an increase in processing capacity along with anxiety over demand conditions. In Europe and Asia, industrial activity indicators are all pointing to a slow start to 2019 as firms adjust to tighter financing conditions, a return to long-run growth trends and the lingering uncertainty of the US-China trade war, among other major policy unknowns (eg, Brexit).
Source: Emirates NBD Research
Synchronized declines in crude and cracks have occurred in the past with cracks whipsawing severely in response to movements in crude. However, with an unfavourable economic outlook weighing on commodities generally, refining margins may give a stronger signal on market conditions this year that could feed back into crude markets.
Markets have been counting on 2019 being the year when US oil production growth slows to a more rational pace. However, the track record of forecasting US’ oil production in the past few years has fallen considerably short. The EIA’s initial forecast for 2018 supply growth (released at the start of 2017) was for growth of 300k b/d. Its latest estimates are that the US added 1.58m b/d last year, a swing of 434%. Forecasts for 2019 have already increased by almost 100% since initially laid out in January 2018.
Source: EIA, Emirates NBD Research. Note: annual forecasts from EIA STEO.
Commodity markets don’t operate in a binary universe of either being long or short and indeed the somewhat conflicting indicators at play in crude at the moment may give a signal that the market is close to being balanced.
With market signals shifting seemingly daily between tight and loose interpretations crude prices will be under considerable volatility. Our forecasts for Q1 imply prices holding an anchor close to current levels (USD 61/b for Brent and USD 50/b for WTI) but we expect to see considerable moves on either side. Provided that OPEC members start to cut back on output, particularly to a large degree by members such as Saudi Arabia or the UAE, then prices should be supported around current levels before rising gradually into Q2.
Oil price outlook for 2019