Oil prices ended higher for a third consecutive month and the Opec meeting last month provided the additional impetus to prices.
Opec and Non-Opec members like Russia agreed to extend their deal for another nine months. Fundamentals remain supportive for prices with demand growth outpacing supply growth globally. US production remains elevated and the response of shale producers to higher prices will now be the most important thing to watch for.
We believe that while the medium-term bias for oil still remains positive, $60-62 will act as a big barrier for prices.
The Opec’s commitment to supply cuts this year coupled with robust demand has led to a drawdown in inventories globally and has resulted in tightening market balances. With the extension of the deal, effectively, oil supply amounting to 1.8 million bpd will stay off markets for another year and help rebalance global oil markets. A nine-month extension of deal was largely factored into price but fact that Libya and Nigeria have informally agreed to cap output at 2017 highs will provide additional boost to prices over medium term.
From a fundamental standpoint, the global oil market has seen a small deficit over the last few months as the growth in global supply has slowed and as Opec compliance to cuts has improved. Opec oil output fell by 80,000 bpd to 32.78 mbpd in October and overall compliance touched 92 per cent.
Saudi continues to be the biggest contributor to the supply cuts but the drop in Iraq’s output by 120,000 bpd helped improve the overall compliance. Nigerian output slipped by 70,000 bpd as some of its exports were under force majeure while Libya pumped an extra 70,000 bpd due to more stable output from the Sharara oilfield. Russia has also reduced its oil output by around 317,000 bpd from 11.24 million bpd in Oct 2016.
On the whole, oil prices have exhibited a strong uptrend in the last few months as fundamentals have turned supportive while geopolitical factors have provided the incremental push. Now, with oil prices near two-year highs, concerns that higher prices could incentivize more supply into the market have come back into play. US production is near a record 9.64 mbpd and projections show that it could surpass 10 mbpd next year.
US rig count additions slowed down in Q3 but the number of oil rigs have started to increase again. In November, oil rigs were up by 20 and the horizontal rig count was up by 28. If the rig count increases going forward, it could act as a strong barrier to oil prices as markets would start fearing a jump in shale production.
On the inventory front, US oil inventories fell by around 4 million barrels last month and are now 6.6 per cent lower compared with the same period last year. US oil stocks have declined by 81 million barrels since March this year. Gasoline and Distillate stocks in the US were also at a two-year lows in November while product stocks at the ARA hub in Europe were down 8.1 per cent compared to last November.
From the demand perspective, crude oil demand has outstripped supply this year as global economic growth remains firm. The demand outlook for next year is a little mixed with Opec expecting higher demand while the IEA lowered its demand forecast. Still, both expect demand to grow by a healthy 1.3-1.5 mbpd next year.
Considering that inventories are edging lower and supply is going to be curtailed next year, we expect the medium term outlook for oil to remain positive. The oil forward curve is also reflecting a tightening market as WTI has moved into backwardation. Net-speculative length was at a one-year low by the end of June but long positions have steadily increased since then and are now near record highs. A test of $60-62 for the WTI is likely over the coming months but intermittent corrections cannot be ruled out. We expect $53-55 to act as a strong base for prices in the coming months.