Crude oil | Short-term bias for crude oil positive, but higher US output to limit upside

By Harshal Barot

Crude oil continued to trade choppy for another week within its recent range as the market grappled with conflicting drivers. While expectations of a tighter market in 2017 supported prices on the lower side, lesser compliance by non-Opec producers and rising US production limited the upside.

Opec producers have cut oil output as per the deal with latest reports suggesting 92 per cent compliance. Opec reports suggested a decline of nearly 0.9 million barrels in output while global oil supplies fell by around 1.2 million bpd last month as per Opec data.

On the other end, US supplies are expected to edge higher in light of the increased rig count in recent months. US rig count jumped again last week and are back near the levels seen in October 2015. On the inventory side, US oil inventories saw yet another big jump last week and partly contributed to weaker prices.

Looking ahead, the short-term bias for crude remains positive and we could see more gains in the coming weeks but higher US output will limit the upside.

The price action in oil market clearly suggests that markets are struggling between factoring short-term and long-term factors. Opec producers have implemented nearly 92 per cent of the agreed cuts with total Opec output falling by 890,000 barrels in January. Supply from the 11 Opec members with production targets fell to 29.88 million bpd last month. Production by all Opec members, including cut-exempted Nigeria and Libya, fell to 32.14 million bpd. Saudi Arabia, which raised oil production to a record this year, took a bigger burden of the cut and has reduced output by more than 700,000 bpd to 9.74 million bpd.

Iraq’s compliance still hasn’t come fully as Kurdistan is still exporting more crude than its quota. Latest reports suggest that Iraq has cut exports by 200,000 bpd so far. In effect, global oil supplies fell by around 1.2 million bpd last month, including 0.9 million bpd from Opec.

We believe 100 per cent compliance could be seen in the coming months which will help prices edge higher. On the flipside, given that Libya and Nigeria are exempt, a rebound in their production will increase Opec output even if other members stick to their quotas.

Nigerian output was higher by 233,000 bpd in January to 1.6 million bpd and could recover to 1.7 mbpd in the coming months. Libya’s oil output is also edging higher and is close to 0.70 million bpd.

Non-Opec compliance, however, has been lacking with reports suggesting less than 20% compliance so far.

The IEA monthly report was also supportive of oil prices as it suggested that oil markets are slowly tightening as demand rises. The IEA report suggested that if the January level of compliance were maintained, the output reductions combined with strong demand growth will help ease the record stocks overhang in the next six months by around 600,000 bpd.

While the production cut is surely medium-term price positive, the biggest limitation is the fact that it will end up providing a lifeline to the same high-cost producers that the Opec intended to push out of business. US oil rig count has been increasing since June and we believe that US oil output may start rebounding this year.

EIA forecasts show that US shale oil production is expected to rise in March by 80,000 bpd to 4.87 million bpd suggesting that shale is starting to make a comeback. The EIA’s own forecasts show that oil output from the US will increase 1.3% to 9 million bpd in 2017, against an earlier prediction of a 0.9% decline.

While the forecast largely considers increases in federal offshore Gulf of Mexico production, shale oil production is also likely to grow in 2017 and 2018.

On the inventory side, US oil stocks unexpectedly jumped by 9.5 million barrels last week. Crude oil inventory increase since the start of this year has been 39 million barrels. Gasoline stocks also saw an increase of 2.8 million while distillates stocks fell slightly by 0.6 million barrels. In Europe, stocks at the Amsterdam-Rotterdam-Antwerp (ARA) were up 6% w/w to 45.83 million barrels. It remains to be seen if reduced Opec supply leads to significant inventory drawdown in the coming months.

Looking ahead, the short-term bias for oil remains positive but higher US output will limit the upside. In effect, it is likely that oil prices remain stuck in a broad range this week as well before we get definite triggers.

Technically, MCX crude continues to consolidate within narrow range of Rs 3,460–3,710 and a breakout is expected soon. Prior bullish trend, lack of volume during dips and lowest ATR since 2008 suggests breakout should be upwards and very sharp. Dip buying near Rs 3,550 or on breach above the Rs 3,710 level is advised.

(Harshal Barot is Analyst for Crude Oil at Motilal Oswal Commodities Brokers. Views expressed are his own and do not represent those of ETMarkets.com)

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