Syed Rashid Husain
HAVING surged almost 80 percent since the January lows, oil markets have moved into an interesting, rather defining phase. With Brent crude heading for its biggest monthly rise in seven years on Friday, touching 2016 highs, we are in the midst of a rally. And in the process, pundits underlining that markets would be decimated, especially in the aftermath of the Doha debacle, were literally undone.
Weak dollar, speculation and falling US production tempered the concerns, in recent weeks, about an excess of physical oil. “The recent increase seems to be mainly spurred by drop in US shale oil production and a few countries’ supply disruptions along with a weaker dollar,” said Michael Poulsen, oil analyst at Global Risk Management.
US output has declined. The US non-conventional crude - that entered the global energy equation with a bang just a few years back - is down - going below 9 million bpd from a peak of 9.7 million bpd seen last April. And this is impacting. Meanwhile, production outages from Nigeria to Venezuela have also taken barrels out of the oversupplied market.
And in the meantime, dollar that has fallen 6 percent this year against a basket of other leading currencies. This too has helped the markets, making the dollar-priced crude cheaper for holders of other currencies, as oil is traded in dollars. A weaker greenback means more affordable prices for traders holding other currencies.
Speculation is also not too far behind. Hedge funds and other money managers have accumulated a record net long position in Brent and WTI futures and options, betting on a further rise in prices equivalent to 656 million barrels of crude, Reuters reported.
The net long position has surpassed previous peaks set this time last year (572 million barrels) and before that in June 2014 (621 million) as Islamic State fighters were racing across northern Iraq and just before prices started to crash. Since the start of 2015, there has been a close correspondence between the accumulation and liquidation of hedge fund positions and short-term movements in oil prices.
Yet despite all this, the million dollar question remains – is this sustainable? Fundamentals continue to point to a weaker outlook. OPEC output is on rise. Supply from OPEC was recorded at 32.64 million barrels per day (bpd) in April from 32.47 million bpd in March, a Reuters survey, based on shipping data and information from sources at oil companies, OPEC and consultants said.
At 3.40 million bpd, Iranian output is now within sight of the 3.50 million bpd it pumped at the end of 2011 before sanctions were tightened. Iraq, which saw the fastest growth in production in OPEC in 2015, also raised its output. Southern exports have risen also to what may be a new record in April - depending on whether tankers loading at the end of the month are treated as April or May. Shipments of Kurdish crude from the north also rose.
Another increase in April came from the United Arab Emirates, following the end of maintenance work on oilfields that produce Murban crude. Also on Friday, Libyan officials said the country's National Oil Corporation has ambitious plans to restore output to pre-2011 levels after years of violence and disruption.
With Iran and Iraq leading the way, the overall OPEC output went up - almost touching in April the highest level in recent recorded history. Deutsche Bank too is now expecting a rise in production by the Organization of the Petroleum Exporting Countries.
Hence warning shots are in air, with some insisting the rally was too soon, and driven in large part by investors taking speculative positions on oil. The colossal net long position has increased the risk of a reversal in prices if the rally were to run out of momentum and hedge funds were to begin liquidating some of their positions.
"The market is massively oversupplied," said Eugen Weinberg, analyst at Commerzbank in Frankfurt. "This rally doesn't have strong legs."
"The issue is that we haven't seen price rallies ... correlate with fundamentals," Hamza Khan, senior commodity strategist at ING was quoted as saying. "The fundamentals — high stocks, high production — haven't changed."
A number of analysts hence have barely nudged up their forecasts as they worry that oil’s recent gains might not be sustainable, Georgi Kantchev reported. Despite the market surge, a survey of 13 investment banks this month saw Brent crude only up $1 from the same survey conducted in March.
The analysts forecast an average Brent price of $57 a barrel next year, but the same banks were predicting last August that Brent would rise above $70 a barrel this year. Hitting that level has now been postponed to 2018.
"Supply and demand are way out of balance, and if you look at stockpiling, we are floating in oil right now," Gina Sanchez of Chantico Global said Thursday on CNBC's "Trading Nation."
Some others are warning that 2016’s price moves could follow the same trajectory as last year when a peak in May was followed by a sharp drop. At the very least, any price gains could be capped. “The latest rebound in oil prices is set to prolong the supply glut and further delay the market’s rebalancing,” said Norbert Ruecker, head of commodities research at Julius Baer.
And while the US commercial crude stocks hit a new record last week, with traders pointing to large quantities of unsold crude being held at sea, Reucker stressed, the US oil output is holding up against expectations, adding: “We see more downside than upside to oil prices.”
With help from the Relative Strength Index, a benchmark used by technical analysts to determine when an asset is oversold or overbought, Andrew Keene of AlphaShark feels the rally could be overdone over the next few months, once the driving season is over. "When the RSI hits 30, as a generalization it's oversold. When it hits 70, it is overbought," Keene said Tuesday on CNBC's "Trading Nation. We see the RSI here hitting that 70 point level. Last time it hit 70, it was back in October. What happened? XOP, the Oil & Gas Exploration & Production ETF, started to head downward, so I think the XOP can head lower." And this is confirmed by the weekly chart of crude oil, which shows that long-term trends continue to point lower.
And even if the rally is sustained - so what? The situation doesn’t remain too bright either. For it could give a fillip to high price output - all around. If oil stays near or above $50 a barrel, it could make drilling attractive again for US shale producers and elsewhere. And this would only exacerbate the issue - adding to the glut and exerting renewed pressure on prices.
The longer-term view is distinctly different form the immediate term. Who would have the last hurrah? A cat and mouse game is on. Let’s await the final round!
