'Market bleed' to remain despite the emerging euphoria

Syed Rashid Husain Is this a dead cat bounce? Oil prices have rallied off the August lows. Brent has been trading above $52 on Friday, breaking range-bound trades since early September that have largely seen the market trade in a $5 band. WTI too has been hovering close to $50 mark. Market sentiments are positive - at least for the time being. A number of factors seem contributing. For the first time over the last few years, US shale industry finally appears on retreat. Total US output has fallen by almost 600,000 barrels per day (bpd) since the end of the first quarter. By next year, the US government expects output to decline to an average of 8.6m bpd, down from an average of 9.3m bpd in 2015. To some it is capitulation. “After hanging on for almost a year, the US shale oil industry is on the brink of complete capitulation,” writes Andrew Critchlow in The Telegraph. Mark Papa, the former head of EOG Resources, underlines this is just the beginning of the downturn in North America. Speaking at the annual Oil and Money conference in London, he said the US oil production growth would tail off this month and start to decline early next year due to weak prices. “We are about to see a pretty dramatic decline in US production growth.” The US oil rig count too tumbled again, after registering the biggest weekly drop, by 26, the week before. As per Baker Hughes report, the number of active oil rigs in the US fell by 9 to 605, putting the count at the lowest since the week ending July 30, 2010. The combined tally of oil and gas rigs fell 14 from last week to 795, the lowest since May 2002. And all this means, lower US output in the coming months. The EIA too is projecting the US crude output to fall through mid-2016. Weakening dollar and the improved demand outlook are also contributing to this growing optimism in the market. The EIA has raised its 2016 world oil demand growth forecast by 100,000 bpd to 1.41 million bpd. However, reports of Saudi Arabia and Russia were finally talking oil, was apparently the biggest contributor to the current spike. Russia's energy minister was reported as saying last week that Russia and Saudi Arabia have discussed the oil market in a meeting and would continue to consult each other. Russia also is ready to meet with OPEC members - as well as non-member oil producers - to discuss the situation, Russian Energy Minister Alexander Novak said. Alluding to a possible meeting with the OPEC, Novak said "if such consultations are to happen, we are ready to take part." In addition, he told reporters that another meeting between officials from Russia and Saudi Arabia was being planned for the end of the month to discuss energy issues and other projects. OPEC Secretary-General Abdullah Al-Badri at a conference in London reiterated that OPEC and non-OPEC members should work together to reduce the supply glut. Oil producers have been hit hard after a sharp drop in oil prices since June 2014 (when a barrel of Brent fetched $114) on the back of a glut in supply and lack of demand. In a bid to support prices and to preserve its market share, rather than cutting production, OPEC opted last November to maintain output. And just a few months back, last May to be exact, when Russia met OPEC, to discuss the dramatic drop in global oil price, it refused to coordinate output cut to stabilize the global crude markets. And thus when reports of a possible coordination between Russia, the world's largest producer and OPEC emerged, markets reacted positively. Yoo-jin Kang, commodities analyst at NH Investment & Securities in Seoul, was quoted in the press as saying that the global oil market was oversupplied and any talk of production restraint was supportive. "As Russia requested talks, investors seem to expect a possible reduction in oil output to be agreed during rebalancing procedures," Kang added. But isn't all this a bit pre mature? Investment banker Goldman Sachs seems so, saying the current oil rally would fade, reiterating its position that crude prices will remain lower for longer. "We continue to view the oil market as oversupplied and with low prices required to achieve the sufficient rebalancing in 2016," Goldman analysts wrote. The investment bank believed the current surge was likely driven by positioning and technicals rather than any change in fundamentals, noting that oil's rally has coincided with a bounce in assets exposed to emerging markets, which typically experience outflows when rates rise. At the same time, crude inventory increases in the United States, Europe, Singapore and Japan point to stockpile buildups above the seasonal norm, the firm said. Goldman further points out that rig counts are rising overseas and that estimates for OPEC's September production put it at August's highs. Last month, Goldman said crude prices could fall as low as $20 if a drop-off in production takes place too gradually. Further a prospect of a real bonhomie between Riyadh and Moscow, while they are at logger heads on Syria, remains remote - to say the least. "Geopolitical tension created by Russia's involvement in Syria makes cooperation with OPEC highly unlikely," said Tamas Varga, oil analyst at London brokerage PVM Oil Associates. "But talk of such collaboration is supporting prices short-term." The decision by Moscow to start bombing targets in Syria will rattle crude prices (and not stabilize), argues Critchlow in The Telegraph. Again Capital founding partner John Kilduff  also believes that it would be difficult for Russia to cooperate with OPEC and coordinate an output cut. "That, to me, is hogwash," he told CNBC's "Squawk Box." And in the meantime, the Saudi decision to lower prices for oil loading in November also shows that the battle for market share in an over-supplied Asian crude market is far from over. Saudi Aramco cut its official selling price (OSP) for its main Arab Light grade to Asia to a discount of US$1.60 a barrel to the regional benchmark Oman/Dubai price for November from a premium of 10 cents for October cargoes. This shows that there is still likely some distance to go, before the current cycle of weak crude prices ends, analysts are hence underlining. Not only market fundamentals continue to stay weak, the ongoing geopolitical scenario too doesn't point to the possibility of a real coordination between Russia and the Gulf oil producers. And that indicates, markets would continue to bleed - for some more time to come - despite the emerging euphoria in the crude world.