The first topsy-turvy quarter of the current oil trading year is behind us, with both benchmarks – Brent and WTI – currently trading above the stated period’s average price well in to the second quarter. In fact, some commentators are quite keen to flag-up the fact that both benchmarks are hovering around price levels not seen since mid-December.
Using Brent, the global proxy benchmark, as a measuring rod – it is also worth remembering that mid-December’s mid-$60 per barrel price level was a decline from a higher mark, that continued into the next month with bearishness entrenched all around. April’s return to the stated level achieved recently is part of a price uptick, if not some sort of an overblown bullish rally.
It also marked the first full month wherein Brent, WTI futures contracts as well as the OPEC basket of crude oils ended each week higher than the one before (see graph below). Not getting ahead of ourselves, all that conveys is that we’ve probably crossed the bottom of this cycle for Brent and the benchmark is likely to stay at or above my equilibrium price of $60.
What becomes crucial from here on is the demand-side of the debate. In that respect, while the global economy may not be firing on all cylinders there are certainly signs of demand picking up, says Jason Schenker, President of Prestige Economics.
“The present fiscal year would be one of consolidation with demand in emerging markets, especially China picking up pace. Furthermore, OECD demand could also pick up as cheaper fuel stimulates usage. At the same time, capital expenditure cutsby producers would serve to reinforce perceptions of supply diminishing to a certain extent if not dramatically, while OPEC is most likely to hold production levels when it meets next in June.
Schenker also shares my skepticism about an imminent and speedy return of Iranian crude to the global supply pool. Even if we were to sidestep a major factor such as Iran’s nuclear compliance with the international community that is needed for it to re-enter the market, chemistry of a cruder kind is a great leveler.
“Refineries that had been receiving Iranian crude years ago, retooled their linear program models to adapt themselves to other blends and grades of crude, in wake of sanctions imposed on the Islamic Republic. In the case of many refiners, the Saudis stepped in to help replace some of the lost Iranian barrels,” Schenker says.
Of course, retooling can take six months, perhaps much longer. Schenker feels what most people ignore is that purely from a petrochemical standpoint you may well run any grade of crude through any refinery. However, what you get at the end of that product wise may not be optimal with more sludge, more slurries, etc.
“What refiners want is optimized yield comprising of more distillates, more gasoline, and not hefty sludge piles via a non-optimized refinery. Linear program models are quite complicated as is the chemistry. This needs to be worked out and can be, but it is not an instantaneous process. That’s if and when Iranian crude is gradually allowed in to the market in meaningful volumes in the first place!”
Iran aside, at this juncture, it is worth assessing how the market is reacting, and consensus is that while both benchmarks are not skyrocketing anytime soon, oil prices are likely to strengthen towards the latter half of the year. I’ve found at least a dozen physical traders in recent weeks who seem to think so and the so-called paper traders are finding their voices too whether you use InterContinental Exchange (ICE) or US Commodity Futures Trading Commission (CFTC) data to draw your conclusions.
Starting with the former, money managers including hedge funds, increased their net long positions in Brent futures and options by 8,351 contracts to 271,929 in the week to April 21, the highest level since ICE’s records began in 2011.
Concurrently, data from the CFTC indicates that net long positions in WTI contracts held by our speculative friends rose by 40,994 contracts to 276,051 in the week to April 21.
While, there is no harm in subscribing to ‘the only way is up now’ theory, it is best to temper expectations between now and the year-end. There is still plenty of crude oil out there and you shouldn’t read too much into weekly Baker Hughes rig count declines as a harbinger of the demise of US shale.
The story of US shale, was, is and will remain a relevant supply-side saga down to ingenuity of the independents wildcatters who kick-started the whole thing in the first place, and the many of will make it work even at a $35 oil price.
As of now, I do expect to see Brent strengthening above $60 and possibly touching $75 come the end of the year. However, barring a major financial tsunami, it’s not going to dip below $30 and barring a major geopolitical shock or sudden supply constriction we won’t go above $75.
Finally, the spread between both benchmarks has widened yet again, but I expect it to narrow down over the course of the year to what I perceive to be a $5 per barrel norm in favor of Brent. All things being equal, while spikes are hard to call, I certainly do see higher oil prices than current levels next year.
The above commentary is meant to stimulate discussion based on the author’s opinion and analysis. It is not solicitation, recommendation or investment advice to trade oil and gas futures, options or products. Oil and gas markets can be highly volatile and opinions in the sector may change instantaneously and without notice.