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Crude prices dip

By David Morrison  |  29/01/2018 15:57
This article looks at some of the factors affecting the oil price and what to look out for going forward

Crude prices dip

Crude was a touch easier in early trade on Monday. This followed on from last week when WTI traded at its highest level in over three years and Brent hit its best level since May 2015. The latest leg in the rally began in earnest back in June and since then WTI is up 57%. The move has confounded those traders looking for a corrective pull-back. But so far Monday’s sell-off looks like little more than a mild bout of profit-taking, triggered by a long–overdue bounce-back in the US dollar.

Modest correction?

Of course, there’s always a danger with crude that a modest correction develops into something more serious. This is due to the speculative nature of the contract. Certainly, speculative positioning suggests that the market is overbought which means it wouldn’t take a big change in sentiment to send prices skidding lower. But a look at a weekly chart helps to put the rally over the last seven months into perspective. While oil has certainly experienced a powerful upside move, it has been a steady advance rather than hyperbolic and there have been a couple of important periods of price consolidation. All-in-all, the move looks measured even though the front-month WTI contract is up close to 140% since it hit a multi-year low under $30 per barrel this time two years ago.

Production cut extended

There are a number of factors playing into the rally. Firstly, we have the deal between OPEC and a number of non-OPEC producers to cut output by 1.8 million barrels per day. That agreement came into effect just over a year ago and is now set to run until the end of this year. Despite early concerns, compliance has been good with most signatories to the deal managing to stick with the plan. This is helping to return global inventories back towards their five-year average. The main concern going forward is that Russia is thought to be agitating to end the deal as soon as that five-year average is hit. Some analysts believe this will result in the agreement being curtailed before the year-end with matters coming to a head at the next OPEC meeting this June.

US inventories decline again

Meanwhile, last week the Energy Information Administration (EIA) released data showing the tenth successive drawdown in US stockpiles. This means that US inventories are rapidly approaching levels where oversupply is no longer a worry. This is yet another factor helping to lift oil prices. Yet on the flip-side US production is once again pushing higher. In the International Energy Agency’s (IEA) most recent monthly market alert, the agency forecast that US oil production looks set to overtake Saudi Arabia and could then challenge Russia for the number one spot. US production is currently at its highest level since the early 1970s coming in around 9.9 million barrels per day (bpd), just a touch shy of Saudi Arabia’s output of 9.92 million bpd. The IEA estimates that US output could average as much as 10.4 million bpd in 2018. Oil prices dropped almost 1% after the report was published, reflecting investors’ fears over possible oversupply. This is a major concern for OPEC as any production cut can be countered by higher output from US shale drillers. Ultimately US producers will end up taking market share from OPEC and those non-OPEC countries involved in the output cut agreement. Last week brought more evidence that US drillers were on the march after oil services provider Baker Hughes reported an increase of 12 oil rigs taking the total to 759, up from 566 this time last year.
Dollar weakness

Looking at wider issues, the ongoing sell-off in the dollar is helping to lift the oil price. Dollar weakness translates into higher prices for dollar-denominated commodities as non-dollar holders get more for their money in terms of the forex transaction. A weaker dollar also adds to US inflationary pressures which increases the attractiveness of hard assets such as oil and precious metals. In addition, there is growing evidence of a synchronised global pick-up in growth and inflation which is expected to feed in to future oil demand growth.

Crude in backwardation

On top of this the crude oil futures market is in backwardation. This means that contracts for future delivery are trading below the current spot price. This tends to support the market as there’s no reason for producers and other commercial players to sell forward contracts to lock in a profit if there’s no premium to take advantage of.

Resistance is now support

Technically, Brent appears to be running into resistance around $70. But WTI continues to consolidate above the $62/62.50 area. This was a band which held as resistance throughout May and June 2015. If it can hold above here for the rest of the week then a move towards $70 can’t be ruled out. But there are dangers – not least the size of the speculative bullish positioning in the market. If the dollar continues to recover, it may only take an unexpectedly large build in US inventories for instance to send holders of long positions rushing for the exit. However, the OPEC/non-OPEC cut agreement together with the positive outlook for global growth should offer support going forward. 


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