From Global Risk Management
The Oil Market Quarterly Outlook Apr'18
From Global Risk Management
The first quarter of 2018 has seen a high level of oil price volatility as Brent oil price fluctuated from lows of $62 to well above $70.
Oil demand has touched all time high; close to 100 mio. barrels per day. As growth in China and India continue to increase, so does their demand for oil. However, production in the U.S. is on the rise, potentially offsetting the 1.8 mio. barrels per day which OPEC and a row of non-OPEC oil producers have taken off the market in accordance with the current oil production cut deal. Just as the geopolitical risk premium over North Korea fades, tensions between huge oil producers Saudi Arabia and Iran flare up. A potential trade war between the U.S. and China also looms and could spur some additional oil price volatility.
GOSI is the Global Oil Strength Index - an index created to evaluate important issues and the effect on oil prices. It answers the basic question: “Are oil prices going up or down from here?”
A high rating is bullish for oil prices and a low rating is bearish. In other words, the index is a lot of information boiled down to one number that indicates whether prices should go up or down.
|Jan. 18||Apr. 18||Comments|
|Fundamentals||55||52||OPEC continues to (over)comply with the oil production cut deal, however, the U.S. continues to ramp up production as well as crude oil exports. Demand for oil is around all-time high, so the increased U.S. production is easily absorbed.|
|Financials||50||55||3 strong economies: India, China and the U.S. have experienced growth in 2018 so far. The USD is dropping and the Fed continues to hike interest rates.|
|Geopolitics||60||57||Tensions between Saudi Arabia and Iran keep the geopolitical risk premium elevated while North Korean tensions have eased.|
|GOSI||55||55||GOSI is above the 50 level - indicating that our oil price expectation is bullish.|
OPEC cut, U.S. production and Brent-WTI spread
Looking at the fundamentals of supply, previous quarter indeed brought a large increase in the U.S. crude oil production. The first week this year the Energy Information Administration (EIA) reported a production of 9.492 kbpd. Latest figures suggest that the production currently is 10.433 kbpd, i.e. an increase of nearly 10% from the start of the year.
A counter-effect to the surging U.S. production is OPEC and its allies’ production cut agreement. As the volume of global oil inventories was very high prior to 2017, the production cut was initiated. It aims at removing 1.8 mbpd of crude in order to decrease crude oil inventories around the world to the 5-year average volume. So far, the compliance rate to the cuts seems decent, and looking at the inventories, a declining tendency is observed. Even though ARA and U.S. crude inventories have increased through Q1, it is still too early to say if the decreasing trend has turned.
The recent rise in U.S. and ARA inventories indicates that the U.S. shale production is possibly offsetting part of the OPEC production cut as the oil demand has not experienced any remarkable drops. Thus it seems plausible that the U.S. has overtaken market share from OPEC.
This is most likely what the U.S. is aiming for - more exports. In Q1-2018 the first ever VLCC tanker left the U.S. Louisiana Offshore Oil Port (LOOP) with crude oil for exports. Such an achievement at LOOP indicates that the U.S. could become a larger player in the export market. The graph below indicates that the exports rose to a higher average level, starting around September last year.
So, what are the implications of increased U.S. exports? The easiest way to analyse it is to look at the Brent-WTI spread, and it has indeed changed remarkably. The spread has gone from a high of about 7$ to 3-4$ in Q1-2018. Concluding that WTI is becoming an increasingly demanded product outside the U.S.
Going forward the production is likely to increase further, although not in a pace as rapid as seen through the 2 latest quarters. Additionally, the U.S. exports are on the rise. Increasing production combined with increasing exports from the U.S. could put a downward pressure on prices, unless OPEC extends the current production cut agreement.
Chinese and Indian demand
The year started off super bullish as demand reached record highs. In January China imported 9.57 mio. barrels per day, versus 7.94 mio. barrels in December. Also, India reached a record high import of crude, summing up to 4.75 mbpd. In the same period the Brent crude price broke through the strong psychological level of 70$ and reached a high of 71.28$.
The very high level of demand could be what, fundamentally speaking, has been a big driver for prices. Since January, prices have decreased to a lower average level as demand cooled a bit as China during February imported 8.45 mbpd.
Going forward the demand is still expected to be strong, especially from Asia as growth there looks bullish.
Demand/supply graph - coming up
Global oil demand is hovering just below 100 mbpd, which is the highest level the globe has ever experienced. With a level this high the spare capacity of production is somewhat squeezed meaning that shocks to the production can manifest quite heavily and quickly in the price. Just a minor outage in production could therefore provoke rapidly surging prices and increased production results in downwards pressure on prices.
The outlook for the supply/demand balance during this quarter is that production is likely to increase further, but demand looks to keep up and prevent a glut.
This section covers Fed politics and the strength of the U.S. dollar as well as growth in India and China
The U.S. dollar has weakened further this quarter, however not in the same pace as last year. The index started the quarter out at about 92.2, from where it reached a low of 88.301.
Last quarter U.S. treasury yields rose to a 4-year high on top of higher than expected CPI and employment figures. However, the QoQ GDP figures showed a decrease in the growth rate from 3.2% in Q3 last year to 2.5% in Q4. In general, the financial figures are decent, but not as high as expected indicating that the U.S. economy is possibly struggling to grow.
The Fed appears to have a different picture of the economy as they are raising interest rates and shrinking the balance sheet. Raising the interest rate traditionally has a slowing effect on the economy i.e. they think it is heating up. Last quarter the Fed increased the interest rate further from 1.50% to 1.75%. Looking at the financial figures; the balance has not changed much since 2015. Furthermore, an increase in the U.S. interest rate would theoretically result in a stronger dollar as it would be more profitable to hold. But what we have seen is that the dollar has weakened. This seems counter-intuitive and is possibly caused by the market lacking belief in the Fed being able to succeed.
As the U.S. is facing a tough job in reducing the balance sheet, and there seems to lack belief in the USD, the effect on oil prices is assessed slightly bullish.
China - higher than expected GDP growth
During last quarter the National People’s Congress (NPC) held its annual session revealing, among others, economic plans and forecasts for the year. They set expectations of the GDP growth to 6.5% which is the same as last year’s expectations but lower than the actual 6.9% in 2017. Other estimates suggest as well that the Chinese economy is going to grow by 6.5% in 2018.
Growth has potentially cooled down a bit in Q1-2018 and the level for Q1-2018 of 1.6% QoQ is likely to persist through Q2. The Purchasing Managers Index (PMI), a measure of production expansion, has been quite high through Q1, therefore, on average it is not expected to increase further in Q2.
The U.S. recently imposed tariffs on imported steel and aluminum, which could affect Chinese exports quite a bit. In turn China has responded with tariffs on 128 U.S. goods. Such a response spurs further fears of a trade war between the two nations, potentially affecting equities markets as well as oil prices. Further escalation is assessed likely to interfere with the price of oil, and possibly the effect will be bearish.
In general, the Chinese economy has performed very well last year. The performance has spilled heavily into the oil market, which is why we are currently seeing high levels of imports/consumption of crude oil.
In Q2 the financials are not assessed to affect the oil consumption negatively, which is why Chinese financials are set to neutral.
India - economy recovering?
India is once again the fastest growing major economy in the world, as their annual GDP growth rate exceeded China at 7.2%, up from 6.5% in 2016. Expectations for 2018 are even higher as the International Monetary Fund (IMF) expects a 7.4% growth. Additionally, the CEO of the National Institute for Transforming India (NITI) says that double digits yearly growth is doable in the future.
Looking at the Indian PMI it has performed very well from mid last year, but was slightly lower in January. However, the PMI is still at a level which suggests expansion. The Consumer Price Index (CPI) for India is higher as well, indicating that the economy is heating up. In general, the financials for India is pointing to an acceleration of the economy. Such a trend has been expected for quite some time now as the Indian economy was heavily affected by political decisions to change the monetary and the tax systems over a year ago. Upon these changes the growth dipped in mid-2017, but is now getting closer to the levels experienced prior to the changes.
Indian financials are assessed bullish.
Indian financials are possibly entering a bullish trend as it seems like the economy is adapting to the monetary and taxation changes. However, there is typically a delay tied to improving financials. Therefore, it might still be too early to say if the improvements are spilling over into the oil market.
As most oil around the globe is priced in dollars, the dollar index historically has had a huge effect on the price of oil. Currently the Fed is trying to shrink the balance sheet which could potentially affect the dollar index negatively. Therefore, the dollar index is a key indicator of where oil prices are going through Q2.
The skirmishes are ongoing with missiles still being launched from Yemen, aimed at various targets in Saudi Arabia. The most recent instance happened on third April 2018 when a Saudi Arabian oil tanker was hit by a missile launched by Houthi movement at the port of Hodeidah. This was just one of many such events in the past few months.
While this tension has been coming up frequently in the headlines, the real risk lies in the continued success of the OPEC+non-OPEC oil production cut deal that was agreed two years ago. The most recent extension agreed in November 2017 has the cut running until end 2018, with a review and a possibility of it ending earlier in mid-2018. The proxy war has led to some doubts that the cut will survive this review point.
This is another layer to the division within the producers involved in the deal, many of whom note that oil prices are too high for their export oriented economies. High oil prices indirectly lead to appreciation of their currencies which hurt exports of other domestically produced goods. Though a concern for certain OPEC countries we do, however, not view this as a major dealbreaker for the cut agreement.
An attempt to place Saudi Arabia and Iran into the respective groups would see Iran in the “oil price is too high” group with Saudi Arabia being in the other. Indeed, this is the case as Iranian Energy Minister mentioned during an interview with Wall Street Journal that Iran was uncomfortable with oil prices being at $70 per barrel as this price level could lead to U.S. production growth which has been increasing to record levels. Meanwhile, higher oil prices favour Saudi Arabia which depends on it as a main revenue stream.
Long term, the confluence of these factors could potentially pose as a danger to the stability of OPEC. In the near term, this geopolitical tension is bullish for oil prices, but going forward, the effect isn’t so clear.
The geopolitical uncertainty is bullish for oil prices.
Saudi Arabian oil production
The country fired 23 missiles in 16 tests done during 2017. The last test was on 29 November which saw the missile fly higher and farther than ever before, eventually landing in Japan’s EEZ. As a result, the UN sanctions committee adopted Resolution 2397 in December which amongst other provisions, included a limit of North Korean import of crude oil and refined products during each 12 month period starting 1 January 2018. Many expected North Korea to retaliate.
However, a breakthrough announcement was made during January 2018 after the two Koreas met for high level talks, the first in two years. North Korea was going to send a delegation to the 2018 Winter Olympic Games held in South Korea. The military hotline that was removed two years prior would also be reinstated. The missile tests and North Korean provocations seemed to fade away into distant memory.
As such, North Korea has not had any bullish bearing on oil prices during the first quarter of the year but it certainly does have the potential to easily be one unexpectedly. Expect the unexpected.
China launched its Yuan denominated Shanghai crude oil futures contract on 26 March 2018. It opened with resounding success with traded volume exceeding that of Brent. With this, the USD’s supremacy as the main reserve currency for commodity trade is now being challenged.
Some sources have revealed to Reuters that a pilot programme for Yuan payment of oil imports could be launched during the second half of the year, with Angola and Russia who are China’s largest suppliers of crude oil, being the first two participants.
This is a significant point as the total annual trade value of oil being around $14 trillion. A small shift in this from USD to CNY would change capital allocations, trade flows and will likely affect geopolitics. A small shift with large, far reaching butterfly effects in many other areas.
With continued success of the contract, pricing benchmarks will likely shift from Platts Oman/Dubai, Dated Brent to reference it for pricing all crude oil basis CIF China. In view of current Chinese capital controls of $50k per person per year on outflow, hedging on oil by mainland Chinese has been severely limited, but not anymore. Furthermore, there is now a way for offshore participants to access China’s oil market directly.
Oil price forecast (average)
Please note that the forecast is the AVERAGE price per quarter. Thus, prices during the quarter will likely be both higher and lower.
in the coming quarter we could see highly volatile prices and Brent oil price within the range of $50-65 is not unlikely should any of the above develop further.
Brent forecast and prices (USD per barrel)
How is the report structured?
The report is divided into three parts – each part elaborates on three main topics which are influencing the oil prices:
The GOSI is the background for the medium term forecast on oil prices. The last pages in the report are our forecast and company news.
The research team
The report is made in cooperation between a group of oil market specialists in Global Risk Management. Contact the team: email@example.com
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