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Oil traders’ confidence shaken by slow impact of supply cuts

Oil traders banking on a sustained market recovery in 2017 are growing impatient.

As the price of Brent crude falls towards $50 a barrel, Opec, energy analysts and some of the most powerful banks in the commodities sector are urging traders to maintain their composure.

After a production cut deal between the cartel and rivals such as Russia was agreed late last year, prices began 2017 $10 a barrel higher and hedge funds quickly amassed record bets backing the push to end the biggest slump in more than a decade.

Confidence has since been shaken as evidence that the cuts are working takes longer than anticipated to materialise. Global crude inventories remain stubbornly high and, crucially, the US shale industry has been reinvigorated by the run up in prices last year. 

“The premature bullishness we saw in early 2017 has had a reality check,” says David Fyfe, chief economist at oil trader Gunvor Group. “The market has been a bit spooked by persistently high stocks.”

The argument in favour of patience rests on the expectation that a big drawdown in stockpiles is expected from the second quarter as supply cuts coincide with refineries processing more crude after shutting down for maintenance. Demand growth is also expected to remain robust this year.

“Balances are heading in the right direction but are not reaching the goal fast enough for most,” say analysts at consultancy Energy Aspects.

“It is a combination of timing and market positioning that has left prices in no man’s land,” they say.

But oil traders are edgy. Even signals from Opec’s de facto leader Saudi Arabia, that producers were working towards an extension of the cuts agreement, has largely failed to lift prices that have dropped 8 per cent in the past week. The global benchmark Brent is below $52 a barrel, while US West Texas Intermediate has dipped under $50.

No matter the recent price tumble, weakness in physical oil prices as well as the futures market, analysts still believe the market is on the cusp of a U-turn. 

If the world’s producers maintain cuts of more than 1.2m barrels a day, stocks in industrialised nations should fall to average levels in the second half of 2017, says Michael Wittner at Société Générale.

The International Energy Agency estimates demand for Opec crude will rise to 33.5m b/d by the end of the year, with the group currently pumping less than 32m b/d.

Mr Wittner says those who expected production cuts that took effect on January 1 to swiftly translate to a draining of crude storage tanks were misguided. They did not factor in a rise in first-quarter inventories because of a surge in last-minute Opec exports before the curbs started.

“Things are moving the right way, hedge funds are just impatient. We saw the exact same thing happen six weeks ago. This is act two of the same drama,” says Mr Wittner.

Speculators cut their net long positions in Brent futures and options contracts by just over 10m barrels in the week to April 18 compared with the previous seven days, according to Intercontinental Exchange data. Analysts say given the recent drop in prices, they expect forthcoming data to show a greater pullback in bullish bets.

An unexpected build in US gasoline inventories and projections for a resurgence in US shale oil production, triggering last week’s price fall, overshadowed US Department of Energy data last week that showed a 1m-barrel drop in US commercial crude inventories to 532m barrels. 

The market, says Mr Wittner, will respond more favourably when there is more such visible evidence of falling stockpiles. 

While there has been a drawdown in inventories held at sea, and in countries where the numbers are opaque, it is difficult to quantify. Oil traders and hedge funds are waiting for data from storage facilities that are easily traceable to show meaningful declines.

Another overlooked factor, analysts say, is that inventories that normally rise in the first quarter — as refineries shut down for maintenance and stop processing crude — have been far smaller than normal.

While the recent price declines may prove temporary, market pessimism is not entirely unwarranted. There are mounting concerns that Opec could be storing up problems for the future, undermined by its own members and rivals outside the cartel.

For now Opec has reached near 100 per cent compliance and the group will probably hold the line with its strategy at its next meeting in May, should Russia agree. But some observers question how long Opec’s own patience will last, particularly if production outside of the cartel keeps rising and pressures prices.

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US shale’s resurgence has surpassed expectations this year and Opec has still not reckoned with the long-term challenge of this new supply source that is fostering technological advances and attracting financing.

US crude oil production reached the highest level in a year in March at more than 9m b/d, according to estimates by the US government. It forecasts crude oil production will increase by an average 1m b/d between 2016 and 2018 if prices hover near current levels.

While Opec has come under pressure to give assurances to oil traders and hedge funds, Seth Kleinman at Citigroup says market participants should have faith in the short term even if uncertainty looms. 

“Clearing inventories of this size is always a messy process, but it is happening,” he said. “There is no doubt about it.”

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