Where Does Oil Go From Here ?


OPEC met last week and the market was eagerly anticipating an announcement on further cuts to production. In the end they announced instead that the current production caps have been extended to March 2018, with no change in quantum. The market was clearly disappointed and expressed their disappointment by pushing oil prices down by 5% on Thursday after the announcement.

Friday saw a slight bounce but oil remained 3% lower on the week (see chart 1). 

 

Capture
Chart 1 : WTI (first active contract, May 21 – May 26)

 

Now the big question on everyone’s mind is, where do oil prices go from here? Forecasting is always a challenge and in this case even more so because it depends on so many factors. We discuss some of them here :

 

1. Will the oil producing countries included in the deal live within production cap guidelines?
This was the big question when the production cap agreement was originally announced back in September 2016. Thus far, the OPEC nations have not only met, but have exceeded their agreed upon cuts. Non-OPEC nations however, have not been playing by the rules. As the chart below shows, the non-OPEC nations have yet to hit the targeted 558,000 barrels/day in production cuts, and on their best month have only achieved 69% of this target. 

Capture

 

2. Do the oil producing countries involved in the deal control enough of the world’s oil production to deal with the supply glut?
This is a big question mark. The efforts to date have seen little impact as measured by global daily oil production. While the OPEC deal has resulted in significant production cuts by OPEC and some non-OPEC countries (1,680,000 bbls/day as of April), this has largely been offset by US producers ramping up production by nearly 900,000 barrels per day, in order to grab market share. Shale oil producers in the US have taken advantage of both the increase in prices since the lows in March of 2016 to put on hedges that will allow them to keep pumping oil even if prices decline again. They are happy to jump in and take market share, and will continue to do so, as indicated by the increasing number of rigs in the US. US producers have added 174 oil rigs in the past four months, which are estimated to add circa 600,000 bbls/day by the end of Q3.

 

Capture

 

3. What happens after the new deal extension expires?
I think it’s safe to say that Putin would like to improve his balance sheet by allowing the oil fields controlled by Russia’s state-owned oil company Rosneft to start producing. They have made heavy investments into these fields, and to let them sit idle must be frustrating. And even Saudi Oil Minister Khalid al-Falih stated that the production cuts do not constitute a “structural intervention” and that they are only intended to manage output for “a restricted period of time {after which they will] allow the free market to work”.

No one wants to keep these production cuts in place in the long run. 

 

4. What are the speculators thinking?
In February 2017, speculative long positions in oil peaked at a five year high as the market anticipated that oil would rally on the OPEC deal. Disappointment has led to the unwinding of these longs, which has put pressure on oil prices. Thursday’s price drop shows that there are more of these positions yet to be liquidated.

Capture

 

Chart 3: Speculative Oil Position

 

The futures curve certainly doesn’t show any expectation of rising prices :

Capture

 

 

So, back to the original question; Where does oil go from here?
With all of the production that has come on line recently, and all of the pent up supply from idle oil fields, plus the fact that the speculative market is still long, tells me that while we may see a period of slightly elevated oil prices, the new cap for oil is somewhere below $60/bbl. It’s a new world, OPEC is just trying to figure out how to live within it.

 

Capture

Chart 4 : Oil (Jun ’14 to May ’17)

 

 

Author : John Glover



 

White Papers


 

FX Hedging:

10 Common Pitfalls

Download> 

Commodity & FX Risk:

An Integrated Approach

Download> 

The Corporate Use of Credit Derivatives:

Where Next?

Download> 

Corporate Hedger’s Guide to Basel III

Download>

Currency Volatility – Are markets nearing an inflection point?

Download>

Testimonial

FX Risk

 

“Validus designed an innovative and practical hedging strategy to address our underlying FX risk in the context of very distinct and diverse sources of competition. We are delighted with the outcome and impressed with their on-going response to the changing business and market dynamics”.

 

Paul Stobbs, Managing Director, Attraction World

Testimonial

Private Equity

 

 “The Validus team understand how private equity thinks about financial risk management issues and they are rigorous in the way they help our portfolio companies to understand and mitigate their risks.”

 

James Markham, Partner – Portfolio Management, Graphite Capital LLP

Testimonial

FX and Commodity Risk

 

“Validus provides us with independent strategic advice relating to our long-term currency and commodity risk management program.  The people are extremely capable and collaborate very well with our finance and operations teams here at JD Irving.”

 

Mark Bettle, Director, J.D. Irving Ltd.

Testimonial

FX  Risk

 

 “Validus developed a tailored hedging solution to mitigate the risks from our unique combination of existing supplier agreements. The implementation and management of this rolling hedging programme with our FX service providers has been expertly and efficiently handled”.  

 

Mark Goldby, Finance Director, SMS Electronics Ltd.

Testimonial

Commodity Risk

 

“Validus worked with us to develop a comprehensive commodity risk management programme – their analysis was both insightful and actionable.   We particularly value their independence, and they continue to work alongside our internal team to ensure our commodity price risks are managed effectively”


Gerry Gray, Finance Director, Strix Ltd.


Testimonial

FX, Commodity & Interest Rate Risk

 

“Validus comes up with risk management solutions that are innovative and comprehensive but practical to implement, that is their strength compared to other consulting companies we have worked with in the past.  Validus provided valuable insights into how FX, interest rate and commodity risks impact our organisation, and provide actionable recommendations and solutions.”

 

Andrew Ayres, Finance Director, U-POL Ltd.

Recent Comments