Is There Still Hope For Higher Oil Prices? By Nick Cunningham

Is There Still Hope For Higher Oil Prices?

By Nick Cunningham

Oil Price, Al-Jazeerah, CCUN, June 21, 2017

Oil prices have cratered in recent weeks, dipping to their lowest levels in more than seven months and any sense of optimism has almost entirely disappeared. All signs point to a period of “lower for longer” for oil prices, a refrain that is all too familiar to those in the industry.

WTI dipped below $44 per barrel on Tuesday, and the bearish indicators are starting to pile up.

Libya’s production just topped 900,000 bpd, a new multi-year high that is up sharply even from just a few weeks ago. Libyan officials are hoping that they will hit many more milestones in the coming months. Next stop is 1 million barrels per day (mb/d), which Libya hopes to breach by the end of July.

U.S. shale is arguably the biggest reason why prices are floundering again. The rig count has increased for 22 consecutive weeks, rising to 747 as of mid-June, up more than 100 percent from a year ago. Production continues to rise, with output expected to jump by 780,000 bpd this year, according to the IEA. Ultimately, the shale rebound appears to have killed off yet another oil price rally, the latest in a series of still-born price rebounds since the initial meltdown in 2014.

Hedge funds and other money managers slashed their bullish bets on crude oil futures in the latest data release. Sentiment is profoundly pessimistic at this point, and because the IEA, OPEC and EIA recently published very downbeat assessments about the pace of rebalancing, a grim mood will be sticking around for a little while. The next reports from those energy watchers won’t come out for almost another month. Related: Iran: OPEC Considers Cutting Deeper As U.S. Shale Beats Forecasts

In the meantime, the weekly EIA data on production and inventories will have outsized importance, mainly because it is one of the few concrete indicators that comes out on a routine basis. Analysts are now worried that a string of bearish data could push prices down even further. "We cannot afford to have another build in crude or gasoline," Bob Yawger, director of futures at Mizuho Securities USA Inc., told Bloomberg before the latest data release. "The market’s just dying for a reason to buy this thing, but you can’t really do that before" the EIA publishes its next batch of weekly data on Wednesday. Gasoline demand also looks weak, just as the summer driving season in the U.S. gets underway, a period of time that typically sees demand rise.

The market got a bit of a reprieve on Wednesday when the EIA reported some decent figures – a drawdown in crude oil inventories by 2.5 million barrels. Also, imports were flat and gasoline stocks fell slightly.

Still, the figures aren’t enough to put the market at ease.

Amid all this doom and gloom, Saudi Arabia’s energy minister Khalid al-Falih tried to put on a brave face, arguing on Monday that the market will “rebalance in the fourth quarter of this year taking into account an increase in shale oil production.” He waved away the recent price drop, dismissing the importance of such short-term movements in the market.

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But with WTI dropping below $45 per barrel, most sober oil market analysts are not nearly as sanguine. OPEC’s objective of bringing global crude oil inventories back into five-year average levels is looking increasingly difficult to achieve, at least in the timeframe laid out by the cartel. “There seems to be very low conviction in the market that there really will be any inventory drawdown in the second half of the year,” said Bjarne Schieldrop, chief commodities analyst at SEB AB.

“This is like a falling knife right now, I genuinely haven't seen sentiment this bad ever,” Amrita Sen, the co-founder and chief oil analyst at Energy Aspects, told CNBC on Wednesday. “We have had clients emailing saying they have been trading this for 20 or 30 years and they have never seen something like this.”

One pivotal factor that could really cause prices to plunge is if compliance with the agreed upon cuts starts to fray. There are several reasons why some participants might start to abandon their pledges. Russia, for example, tends to produce more oil in summer months, a fact that might tempt them to boost output. Iraq is also eyeing higher production capacity this year. In addition, weak prices could start to undermine the group’s resolve. "Lack of major upside price response to the OPEC output cuts upping the odds of reduced compliance to the agreement in our opinion," Jim Ritterbusch, president of energy advisory firm Ritterbusch & Associates, wrote in a research note.

Moreover, simmering conflict in the Middle East could continue to grow, threatening to derail cooperation between OPEC members. The conflict between Saudi Arabia and its Gulf allies on the one hand, and Qatar and Iran on the other, could deteriorate. Although that could spark some price gains for crude oil if supplies are affected, it could also undermine the OPEC deal.

One unknown factor that could prevent oil prices from falling further is the possibility that prices floundering in the mid-$40s actually puts a lid on shale production. If U.S. shale underperforms over the next year, the OPEC deal could succeed in balancing the market. But if U.S. shale continues to rise, and OPEC fails to extend its deal beyond the first quarter of 2018, oil could fall to $30 per barrel, according to Fereidun Fesharaki, chairman of consultants FGE.

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Oil Prices Are Set To Rebound

The latest selloff in oil prices have left speculators in a predicament: The fundamentals continue to look poor with unimpressive drawdowns in crude oil stocks, but there is a general consensus that the extension of the OPEC deal should push the market towards a rebalancing over the next few quarters.

What that means for short-term movements in prices is unclear. The unpredictability of today’s oil market is leaving some investors burned by unexpected price gyrations. For example, just ahead of the recent selloff in prices last week, oil traders bought up bets on rising prices. Hedge funds and other money managers increased their bullish bets by 7.3 percent for the week ending on June 6, but prices plunged by 5 percent a day later.

Traders looking for some direction might want to consider the futures market, where a contango structure has reemerged. A contango, in which near-term oil futures trade at a discount to futures dated further out, is a symptom of oversupply. For example, two weeks ago, futures for December 2017 traded at a $1 per barrel discount compared to contracts for delivery in December 2018. That discount ballooned to $1.49 per barrel last week, according to Bloomberg, a sign that investors are growing more pessimistic about oversupply conditions this year. "Brent spreads are getting clobbered," Amrita Sen, chief oil market analyst at consultants Energy Aspects Ltd., told Bloomberg. "The Atlantic Basin is awash in light crudes from Nigeria and Libya."

The December 2017-December 2018 spread is now deeper into contango territory than at any point since the original OPEC deal back in late 2016. In recent months the spread was positive – that is, the December 2017 contract traded at a premium compared to contracts a year later, a situation known as backwardation.

Several investment banks have insisted that OPEC’s best hope at draining inventories was to do just that: Induce a state of backwardation into the market. By driving up near-term prices while pushing down the back end of the futures curve, the argument goes, OPEC could scare off shale drilling. Producers would be deprived of finance by skittish lenders, and they would be reluctant to drill if they expected prices to be lower in the future. OPEC could achieve this state of backwardation by maintaining cuts this year while also signaling production growth in the future.

If that is the strategy, so far it has not succeeded. The reemergence of the contango reflects concerns about the glut persisting through this year.

Meanwhile, investors are growing wary of an energy market that continues to spurn them. Energy companies have been among the worst performing stocks in 2017. The poor results are leading to an exodus of capital from energy-linked exchange-traded funds (ETFs). Over the past three months, more than $300 million have been pulled out of energy ETFs, according to Bloomberg, which will likely result in the first quarterly outflow of capital from energy ETFs in more than two years. "People are re-allocating money to sectors that are performing better, technology or health-care, versus sitting on a sector like energy that’s down 10 plus percent," Jeff Carbone, managing partner of Cornerstone Financial Partners, told Bloomberg. "We’re bottoming, but what pushes it higher? That’s the hard part."

The flip side is that some think that the selloff in energy is overdone. That is exactly why hedge funds and other money managers bought up a greater net-long position in early June, even though some might feel they got in at the wrong time. Nevertheless, the cratering of oil prices last week has opened up a buying opportunity. "When you start to approach $45 a barrel in WTI, you're in an area where you do find some price support and I think there has been some evidence last week of investment flows coming back into crude oil," Petromatrix strategist Olivier Jakob said in a Reuters interview. Jakob cautioned that the room on the upside could still be limited. "You have to be careful not to be too optimistic for now," he said. "Physical differentials are still under pressure and the time structure is still under pressure in Brent. It's a bit premature to call for much higher oil prices."

So what happens next depends on who you ask. Market fundamentals look weak but some traders see attractive entry points.

Link to original article: http://oilprice.com/Energy/Crude-Oil/Has-Permian-Productivity-Peaked.html

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