Two dominant factors to influence oil markets this year

Opec's possible end to its self-imposed cuts is one, while the second is the developing situation in US Shale supplies

Saudi Arabia and some other Opec members are signalling output cuts. AFP

A pricing-in trend prevailed in the oil markets during the last week of May. Iran tensions appear to have added a premium and sustained Brent crude at multi-year highs. Following that, Opec’s expected tapering of supply cuts by the end of the year limited Brent’s rally, disappointing the oil bulls who were expecting sharper rises.

The changing conditions drove a wedge between Brent and WTI, further diverging the spread to its highest levels since March 2015. The $11 difference between WTI and Brent was not allayed by Russia and Saudi Arabia committing to boost supplies to replace Iranian exports. Nor were investors convinced by Opec’s turnaround on supply cuts, especially given the fact that US supplies continue to indicate abundant supplies. Markets reacted to the confusion by returning to demand and supply fundamentals.

At the time of writing, the spread between Brent and WTI reflects a premium priced in for Brent, which seems to have more supply challenges than WTI, and a discount for WTI because of the plentiful supplies stemming from US Shale.

The second half of the year appears to hold two dominant factors for the oil markets. The first is that Opec is mulling an end to its self-imposed cuts. The reactions to this development are mixed. There are reservations over Opec’s upstream capacity to power up strongly given the lower levels of investment in recent years, adding to perceived pressure on future supplies. A

At the same time, drop-outs in supplies from Venezuela and Iran are a pressing factor on current global supplies. These two arguments tend to buoy up Brent crude’s price. Still, at the back of investor’s minds is the thought that prices may lack support if the supply tap is turned back on to full by the end of the year.

Fundamentals rarely lie. Unless global demand and regional demand convincingly match or exceed supplies, Opec’s return to full production at pre-2016 levels would simply reintroduce an over-supplied market, meaning that prices may return to lower levels.

________

Read more:

Oil bulls gain ground following US pullout from Iran nuclear deal

While the US dollar shone in May, it is now taking a breather

________

The second dominating factor is the developing situation in supplies from the US Shale industry. By the end of May, the US's Energy Information Administration reported that US crude oil imports had dropped by 5.5 per cent compared to the same period last year. Parallel to that, during the week ending on 25.5.18, US Shale output increased by 1.4 million barrels per day compared to the same period in 2017, while increasing by 44,000 b/d compared to the week before.

Rising output and reducing imports mean that there may be less demand for global oil from the gigantic US market in the short term.  It appears that there are more divergences in the international oil markets than just the WTI-Brent spread. US Shale is sucking up the domestic demand for crude oil and producing enough to export as well. Opec’s return to full production may make Brent crude more competitive but there’s an undeniable risk that both benchmarks may court the weakness of an over-supplied market.

There’s little doubt that it’s a delicate stage for the oil markets. Opec’s re-balancing policy had the desired effect of bringing crude oil benchmarks back up to the target range of $50 to $60 per barrel. The rally in May appears to have boosted the oil bulls’ confidence, but now that there’s a return to supply-and-demand basics , the question is whether it’s too soon to end supply cuts. It’s all eyes on Opec’s June 22 meeting, when the oil markets expect more clear signals of what lies ahead for the bloc of oil producers.

Hussein Sayed is the chief market strategist at FXTM