EXECUTIVE SUMMARY

Crude oil market was trading in a narrow range above $50 per bbl in January.  It looks like this period of low volatility will come to the end soon and risks are skewed to the downside.

Bearish risks for crude oil price are now almost palpable in over-concentration of speculative net longs in U.S. oil futures and options. The logic is simple, usually if the market is bullish, the rally should have been continued on all the news about high rate of OPEC cut implementation since the beginning of the year. Instead, the market has gone in consolidation in spite of buying more than 100 thousands lots of WTI futures and options at NYMEX by Hedge Funds since December 6.  

OPEC and non-OPEC countries are implementing about 80% of November cut deal, according to monitoring committee.  Several members of the Organization of Petroleum Exporting Countries say they’ve already made their pledged reductions, with Saudi Arabia, Kuwait and Algeria saying they’ve cut even deeper. Saudi Arabia, OPEC's largest producer and the world's largest crude oil exporter, has set the precedent with its minister recently saying production this month was less than 10 mln b / d, its lowest output in almost two years after hitting highs of 10.72 mln b / d late last year. Preliminary data from the Russian energy ministry's Central Dispatching Unit indicated that output was down by as much as 150,000 b/d on some days in early January, although this was largely due to abnormally low temperatures in some oil producing areas.

The Organization of Petroleum Exporting Countries pumped 32.3 mln b / d in January, according to a Bloomberg News survey of analysts, oil companies and ship-tracking data. The 10 members of the group that pledged to make cuts in Vienna two months ago implemented 83 percent of those reductions on average, but their efforts were offset by increases from Iran, Nigeria and Libya that were permitted under the terms of the agreement.

Accounting for the members who raised output and the suspension of Indonesia, OPEC’s total output remains 550,000 barrels a day above the target set out in the Nov. 30 deal. That means the group as a whole is only about 60 percent of the way toward the production level it deems necessary to eliminate a global oversupply and boost prices.

OPEC is hoping to achieve 100 percent compliance with the pledged reductions, according to the Kuwaiti oil minister, who is chair of committee that monitors the agreement. In the last organized cuts in 2008, OPEC’s compliance rate stood at 70 percent, according to Hasan Qabazard, OPEC’s former head of research.

The reasons for the market to ignore bullish OPEC high compliance level:

1.       Firstly, cheating is highly expected from export countries.

According to Platts, market analysts are cautious about drawing any conclusions until data for the full month of January is released on February 2. CDU data will be used to assess Russian output throughout the duration of the deal.

2.       Even if hard data will prove high rate of this cut implementation, there is no trust in how long it can last.

Hence, this is only voluntarily cuts each country could try to sell some more at substantially high prices. These countries’ economies are mostly relied on crude oil export and some of them are in difficult financial situations to avoid such opportunity to get more export dollars (Venezuela, Iraq etc.).

3.       Lastly, market fundamentals is likely so weak that pledged  OPEC + non-OPEC 1.8 mln b / d oil production cut may be just not enough to support higher prices.

When OPEC calculated volumes of production to cut in September last year, U.S. oil production was declining. Now, it is on the rise again. The more successful OPEC and non-OPEC producers are in speeding up the market rebalancing and pushing up prices, the quicker the turnaround in output from the likes of the US, Canada, Brazil, China and Colombia, which could counterbalance the cuts. The IEA has predicted US shale will make a 500,000 b/d gain from December 2016 to December 2017. Pace of demand growth this year may be overestimated. In the USA, gasoline glut is getting worse. Demand covering ratio is now more than 30 days of supply. In other words, gasoline inventories would last 30.7 days, the highest level since March 1995.

Possibly, the market is in supply/demand balance point now and that is why crude oil volatility is so low. In that case the oversupply in world oil storages would not be lowering and will be putting pressure on crude oil, prohibiting the price from continue its rally. Additionally, expected decline in compliance from OPEC (perhaps, some cheating), positive surprises from U.S. shale oil production can return crude oil price below $50 per bbl.

Crude oil production in the USA  kept on rising in January by 125 thsd bbl / d or 1.4% up to date (the most recent data is for Jan-20) in comparison with December data and decreased by 319 thsd bbl / d or 3.5% in comparison with January 2015 figures. January was the third month of increasing production in a row from lows 8.49 mln bbl / d in October. Total production of shale oil in the US in January slightly added 19 thsd bbl /d over December data and on the year-on-year basis the decline rate was equal to 6.2% or 329 thsd bbl / d.        

Crude oil demand numbers from China will be especially crucial for the market this year, because there is so much talking now about peak oil demand in the coming years. In December crude oil import in China jumped to a record 8.6 mln b / d. Crude imports by Chinese teapot refineries are at record high of 5.97 mln tons in January. Average imports in 2016 doubled comparing to 2015 and were at 3.5 mln tons per month level. The government limited further rising by quotes for private refineries, but current increase is still considerable one comparing to last year average. The government has now approved the teapots to buy a total of 68.81 mln metric tons of crude from overseas under a first batch of allocations for 2017, according to officials from companies that received the notification. Of that, 45.64 mln tons can be bought directly by the private refiners (3.8 mln tons per month). The rest will be processed via state-owned traders and other agents.

According to Platts calculations, China's apparent oil demand, excluding output from independent refineries, slipped into the negative territory in 2016, a sharp reversal from the near 7% growth witnessed a year earlier, as the country's slowest GDP growth in 26 years slashed appetite for industrial and transportation fuels in Asia's biggest oil consuming nation. However, if output from the independent sector is taken into account, apparent demand last year is estimated to be around 11.34 mln b / d, representing 1.3% year-on-year growth. Platts forecasts China's apparent demand will reach 11.57 mln b / d in 2017, a 2% increase against the adjusted numbers for 2016.

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08 February 2017, Arbat Capital

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