Yesterday Brent crude prices jumped by over 5% to over $40.50 per barrel, the first time the oil price has risen above $40 per barrel since early December and up more than 40% from its January low. But, could this be a false dawn for oil prices just like in 2015?
Loss of confidence in output freeze: Saudi Arabia, Qatar, Venezuela and non-OPEC member Russia agreed last month to freeze output at January levels, but only if others do the same. Russia’s energy minister has indicated that a meeting between OPEC and other leading energy producers could take place between 20th March and 1st April. However, the market could quickly lose confidence in the initiative, even if there is agreement. The key to an agreement taking hold will be Iran’s participation, but it is unlikely to want to cede acquiring market share now that sanctions have been removed. Recent isolated cuts to output (Iraq, Nigeria) were more to do with unrelated geopolitical than an attempt to actually control output.
US shale responds: The decline in US shale output may slow or reverse if operators can take advantage of higher crude prices and hedge near term and future production. A price near $45-$50 per barrel is break-even for many. Although shale is more responsive than conventional production it still operates with a lag. Drilled but uncompleted wells could result in output returning faster than the market thinks.
According to Goldman’s:
“…given the short-cycle nature of shale production and the only nascent non-OPEC supply response to OPEC’s November 2014 decision to maximize longterm revenues. We think it would likely require a period of weak economic and oil demand growth to see a broader agreement to curtail production.”
Oil prices are unlikely to stabilise until inventories stop building: Crude storage tanks aren’t just brimming in the U.S., but across the world. A year ago, the International Energy Agency was sounding this warning:
Barring any unforeseen disruption, OECD stocks may by mid-2015 come close to revisiting the all-time high of 2.83 billion barrels reached in August 1998, shortly before WTI prices sank to an average monthly low of $11.22/bbl.
As it turned out, commercial stocks of oil held in OECD countries had already risen above 2.9 billion barrels by the middle of 2015 — and then kept going.
Demand fails to grow as fast as predicted: Demand for oil is generally forecast to grow slower than in 2015, nevertheless the outlook for oil demand growth is becoming more uncertain. More from Ed Morse:
Not only has the outlook for global GDP growth started to grow dimmer this year, but the relationship between GDP growth and oil demand is starting to diverge in substantial, structural ways. China, which has been the engine to high prices for all commodities and especially energy commodities, is sputtering. Diesel demand in China peaked in 2011 and is looking increasingly unlikely to start growing again any time soon, if ever.
He goes on to say:
Most tellingly, oil has started to lose its one remaining monopoly as a transport fuel as competition from natural gas and electricity appears inexorably on the rise.
Indeed, competition with natural gas implies a much lower oil price.
There has been a shift in sentiment, but sentiment is just that and can change again. According to Barclays:
“Many of the factors that have supported the recent upward trend in commodities look transient”.
Back in 2015 Brent crude oil prices peaked in early May at $68 per barrel. Watch out for oil to peak around the same period this year, but at a lower level of around $50 per barrel.