OMR: Waning confidence
13 July 2017
Oil investors are going through a period of waning confidence with prices recently returning to levels not seen since early November. Brent prices have closed below $50/bbl each day since early June and few investors expect a recovery anytime soon. Money managers slashed net long positions in Brent and WTI crude futures by more than 200 mb between end-May and end-June, to 312 mb. This was the lowest net long position recorded since January 2016 and June was the fourth straight month of falls in net long positions since a record bullish position was achieved in February in the euphoria following the output agreements. The widespread interpretation of this is that investors believe, perhaps impatiently, that oil market re-balancing is taking too long with some calling for additional action by producers to speed up the process.
Each month something seems to come along to raise doubts about the pace of the re-balancing process. This month, there are two hitches: a dramatic recovery in oil production from Libya and Nigeria and a lower rate of compliance by OPEC with its own output agreement. In the past few months, Libya and Nigeria have seen their combined output increase by more than 700 kb/d. For fellow OPEC members, who agreed to reduce production by 1.2 mb/d, to see their cut effectively diluted by nearly two-thirds must be very frustrating, especially as their pact has, hitherto, been well observed by historical standards.
The second internal issue for OPEC is that its rate of compliance now appears to be slipping. Data is subject to revision, but our current view is that compliance slipped to 78% in June from 95% in May. While the top producer, Saudi Arabia, continues to deliver on its promise to cut output, several other producers have not so far fulfilled their commitments. However, the output agreement runs until March 2018, and success is judged over the whole period rather than in one month. It is OPEC’s business to manage its output and we must wait and see if the changing supply picture from the group as a whole forces an adjustment to the current arrangements. In passing, it is worth noting that compliance from the ten non-OPEC producers who volunteered to cut production improved to 82% in June, higher than the rate achieved by OPEC.
The recent price weakness may lead the US shale patch to reassess its prospects. Financial data suggests that while output might be gushing, profits are not and recent press reports quoted leading company executives saying that oil prices need to be around $50/bbl to maintain production growth. WTI values have not been consistently above that level since late April. Meanwhile, we saw a record twenty-three consecutive weeks of rising drilling activity grind to a halt, although modest growth has resumed. Such is the resilience of the US shale sector that we should be careful to pronounce that its expansion will slow, however it could be that the recent exuberance is being reined in. For now, we have left unchanged our view on US production and, for that matter, on the prospects for non-OPEC production as a whole.
Meanwhile, preliminary indications suggest that global demand growth, after falling to a three-year low of 1.0 mb/d in 1Q17, rebounded to 1.5 mb/d in 2Q17, with strong year-on-year data for the OECD countries as well as in developing economies. Taking demand and supply together, the current market balance implies a global stock draw of 0.7 mb/d in 2Q17. For now, actual stocks numbers do not support this picture but, at the time of writing, data for the quarter remains incomplete and, in any event, numbers for previous months can be revised. Thus, we need to wait a little longer to confirm if the process of re-balancing has actually started in 2Q17 and if the waning confidence shown by investors is justified or not.