Oil, which slid from a six-month high at just over US$48 ($65.5) a barrel on April 28, has remained well-supported after an ongoing wildfire in Alberta, Canada, took out at least one million barrels in daily production capacity, or about a third of the country’s daily production, reports said. Brent crude was trading at US$45.70 per barrel on May 9, which is up by more than 20% since the start of the year.
Oil prices have rebounded as a result of falling US production in recent weeks, with many shale producers forced out of business when prices fell to a 13-year low of US$28 a barrel in January. Data released by the Energy Information Administration May 4 revealed that US production fell by 113,000 barrels a day to 8.8 million in the last week of April, the biggest weekly drop since August 2015. Supply shortages in Nigeria and Northern Iraq and the weaker US dollar have also helped to support prices.
Yet, some analysts see oil prices falling back to US$35 a barrel this year. One reason is the Organisation of the Petroleum Exporting Countries’ failure to agree on an output freeze which could raise supply and bring oil prices down. Indeed, production rose after a meeting between producers of the cartel to discuss a freeze fell apart last month.
A subsequent May 4 meeting between OPEC producers saw the proposal move further down the list of the cartel’s priorities, when delegates were reported to have said that a freeze is no longer necessary given that oil prices have rebounded. Opec’s production plans are even more uncertain now that Saudi Arabia has replaced veteran energy minister, Ali al-Naimi with Khalid al-Falih during a government restructuring which took place over the weekend.
Another reason for the lower prices to come is rising US inventories. Despite the fall in production, US crude inventories have increased by 2.8 million barrels a day to 543.4 million in April. “Oil prices are going to stay volatile due to the uncertainty over when the market will rebalance. In other words, the world must first stop building up inventories,” says Harry Tchilinguirian, global head of commodity markets strategy at BNP Paribas.
“Because all the OPEC meetings so far have ended in disarray, the onus is now on US shale producers to cut output, without which it will be very difficult for demand and supply to find a balance,” he says.
The way Tchilinguirian sees it, even though oil prices seem to be rebounding, higher prices over the shorter term will likely make things worse. “This is because any rally in oil prices throws a lifeline to the US producers who are struggling to stay afloat from low oil prices. It provides better levels for them to hedge and maintain production levels,” Tchilinguirian says.
“There is a possibility that the decline in US oil production turns out shy of market expectations, which will lead to a big correction in prices to the US$35 per barrel level again, prolonging the time taken for the cycle to turn up sustainably,” he adds.
Another reason for oil prices to revisit US$35 per barrel levels is decelerating demand. “Demand for cars in the US may be rising fast but this is being offset by demand from US oil refineries have also started to slow because margins are tightening. The refiners are not going to buy as much oil at higher prices if it means less attractive margins and this will see US inventories stay higher for longer,” says Ole Hansen, head of commodities at Saxo Capital Markets.
Dominic Schnider, head of commodities at UBS CIO Wealth Management, agrees. “We have noticed that the rise in demand for oil, which accelerated when prices first dropped in 2014, has slowed down of late. The latest demand numbers have actually not been that great and China is one of the main reasons for this,” he says.
In 1Q2016, apparent oil demand in China averaged 11.1 million barrels a day compared with a 7.5% expansion in apparent oil demand during the same period last year, according to government data. China’s apparent oil demand this year is forecasted to grow by less than 2%, says to Song Yen Ling, senior analyst with Platts China Oil Analytics.
“In essence, we are still far away from seeing crude prices rise sustainably. Any rise in price we see now will only invite increased production, and that will send oil straight back to US$35 a barrel,” Hansen says. “We are months away from the market rebalancing.”
This article first appeared in The Edge Singapore Market Report.