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Oil riding on many positives, how far will it go?


By Navneet Damani

Oil prices have traded firm supported by geopolitical premium, which overshadowed negative data of continuous rise in US output. There are plenty of reasons to be bullish about oil — rapid growth in global crude consumption, continued supply restraint by Opec, falling output in Venezuela and possible re-imposition of sanctions on Iran.

US exports are increasing continuously and have surpassed Nigeria's due to widening of spread between WTI and Brent. The spread between Brent and WTI is close to $6 per barrel, with premium on Brent, which is supported by global supply risks. WTI is bogged down by relentless increase in shale oil production.

The difference implies that Brents greater premium on WTI has been beneficial for US producers to ship more crude overseas to offset Opec's voluntary supply cuts and potential supply declines elsewhere. Total US exports, meanwhile, are more than double what they were last year at average of 1.67 million bpd. This could change, however, as US refineries kick into high gear for summer travel season. That would mean less US crude oil in the global market and pull WTI higher towards Brent. US exports will continue to rise in the medium term, and by 2022, the country will be fourth biggest oil exporter in the world behind Saudi Arabia, Russia and Iraq.

US oil rigs have been increasing this month and have touched their highest level since March 2015. The US government expects oil output in the Permian to rise to a record high near 3.2 million barrels per day in May. That's about 30 per cent of total US oil production, which keep pressure high on crude oil prices.

Geopolitical tensions are heating up yet again on President Donald Trump's recent remarks on Iran and uncertainties about a nuclear agreement that has been in place since 2015. Territorial tussle in the Middle East is another overhang for oil markets. The prospect of heightened unrest could drive oil prices up, in addition to other market events.

The Opec seems to be reformulating its target in terms of upstream investment rather than oil inventories. The bloc is working on rebalancing the market, which is far from complete. If Opec members wait for an acceleration of upstream investment before relaxing production curbs, they will almost certainly over-tighten the market.

The oil market is already tight and the increasingly wide backwardation points to more tightening during second half of the year when oil consumption gets seasonally higher. The resulting increase in prices and spreads will accelerate production growth and start to weigh on consumption.

Another risk that will be keenly tracked is Trump's attack on Opec for output cuts. The curbs have helped drive oil prices to about $74 per barrel — their highest since late 2014. Sanctions on Iran could send prices even higher by $5 a barrel.

Further, plunging output in Venezuela is catching the worlds attention. Problems are quietly festering in another Opec nation, Angola, where crude output is falling rapidly on lack of investments in offshore fields. And this could tip the oil market into a deficit.

The latest Monthly Oil Market Report by the Opec reveals that in the first quarter, Angola produced 1.57 million bpd of crude, down from 1.63 million bpd previously. In March, average daily production was lowest for the quarter, at 1.524 million bpd, down by 81,700 bpd from February and it is believed that the decline will continue, and even accelerate.

The most crucial event this month will be US decision on sanctions on Iran. Oil markets are also assessing the impact of a likely collapse of Iran nuclear deal and re-imposition of US curbs on Iran. Should the sanctions materialise, approximately 1 million barrels of Iranian crude will dry up from the market as it produces 3.8 million per day, making it the third largest oil producer in the 14-member Opec after Saudi Arabia and Iraq.

Iran ships about 2.5 million barrels a day.

For the Opec, sanctions on Iran will make it easier for them to meet its self-imposed production quotas. Saudi Arabia and Israel are trying aggressively to convince the President to be tough on Iran. If Iran is prevented from exporting as much oil as it has been, the Opec will more easily meet its targets. Saudi Arabia will also have an easier time convincing all of its partners, including Russia, to extend quotas into 2019.

In addition, if tension between Iran and Opec or non-Opec producers flares up, there will be efforts to raise production capacity, which could be used as a viable political leverage against Iran.

Meanwhile, natural gas gained on the back of a colder than expected weather outlook. But concerns remain as
the second-half could see more normal to warmer weather conditions. The bullish development is US LNG exports have reached an all-time high. Natural gas production in the US is up over last year, and that should continue to be a major factor, going forward. Overall choppiness is likely to prevail in natural gas for the medium term. We might see huge volatility in coming weeks before we get any clarity on sanctions.

We expect WTI prices to be in a broad range with support at 66.50/65.50 and resistance at 69.50/72. A breach above or below this range would give further confirmation for a 8-10 per cent direction move.

(Navneet Damani is AVP Research at Motilal Oswal Commodities. Views expressed in this article are author's own and do not represent those of ETMarkets.com)

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