- By announcing a production freeze, the global oil coalition has set a floor under oil prices
- Maintenance could postpone an oil price recovery
- Gas prices trade around historic lows
Technical resistance levels being tested
On Friday, 26 February, oil prices rallied in light of better-than-expected US growth data. As a result, Brent oil tested the technical resistance line (USD 36.25/bbl), which is roughly similar to the longer-term downward trend line (figure 1). WTI shows a similar picture, with resistance around USD 35/bbl. If these technical levels are broken, more and more market participants could become convinced that the floor – set by the coalition of oil producers – is sustainable. This, in turn, could trigger a further unwinding of speculative short positions, resulting in increased oil price support.
Verbal intervention sets floor under oil prices
On 16 February, several oil producing countries agreed to no longer increase (freeze) their oil production compared to January levels. Venezuela, Qatar, Russia and Saudi Arabia took this decision in order to put an end to the slide in oil prices. Although the market had hoped that some of these producers would immediately cut oil production, we still see this agreement as a strong message to the market. The agreement is based on January production levels, and will start in March. The only country which would actually be able to increase production – Saudi Arabia – clearly indicated via this message that oil prices below USD 30/bbl are not sustainable. We believe that Saudi Arabia is willing to cut production if the market forces it to do so. Iraq indicated that it will join the agreement to freeze production at January levels, bringing the total volume of the production freeze to one-third of global oil production. And market expectations suggest that additional oil producers will also join in the coming weeks. If, as expected, global demand increases by 1.2-1.5 million barrels (as projected by the International Energy Agency (IEA)), and production stabilises or even declines, the global oversupply will diminish and prices will face some upward pressure. Finally, since we no longer forecast a strong rally of the US dollar in 2016 and 2017, the currency will not have a dampening effect on any oil price recovery.
US and Iran will not join in
Two large oil producing countries will not join the production freeze agreement, namely the US and Iran (Figure 2). In the US, there is not just one or a few oil producers who can be told to freeze or cut oil production. Instead, there are hundreds of smaller oil producers who will continue to produce oil as long as this is economically viable. And this is the case at ever lower oil prices now that producers are critically considering production costs, and production efficiency has increased. Nevertheless, it takes quite some effort to keep production at current levels, let alone intensify it. As a result, the low oil price has also triggered a stabilisation of US oil production.
Iran will also refrain from joining the agreement. Far before it reached a deal with several western countries regarding its nuclear programme, Iran indicated that it will attempt to restore its production to pre-sanction levels as soon as possible. This means the country will try to increase its production by at least another 600,000 barrels/day. Iran has clearly signalled that it will try to regain all the market share it lost in recent years, and that the low oil price is mainly a problem that was created by other oil producers. Its efforts to regain its lost market share mean Iran is placing responsibility for solving the oversupply problem with the other oil producers who increased output, and did so partly at the expense of Iran. Nevertheless, the boost in Iranian oil production is fully priced in and could only disappoint if Iran cannot meet these market expectations.
Downside risks due to refinery maintenance
Still, there are downside risks to an upward correction of the oil price. Obviously, the oversupply of oil continues to hang over the market, which limits the upside potential. Nevertheless, we must keep in mind how oil prices have developed in recent months. Even after a recovery towards USD 40/bbl or somewhat higher, oil prices are still significantly lower compared to eighteen months ago.
Another factor is the start of the maintenance season at refineries. During the traditional switch from winter to summer production, refineries shut down to perform maintenance. However, last year in particular, refineries postponed most maintenance due to good margins, which means this year’s maintenance round will definitely take place. As a result, the demand for oil will be temporarily lower, which may result in a) pressure on oil prices due to lower demand and/or b) a further increase in oil supplies while storage capacity is starting to become scarce in certain locations. In addition, these high crude inventories could again dampen upward price potential, or even trigger new downward pressure on oil prices. Either way, direction will be set by the news headlines and can change from day to day. For now, the only certainty regarding oil prices remains their continuous high volatility.
US natural gas tests 2015 lows
US Henry Hub natural gas prices touched a new record low of USD 1.682/mmBtu. The combination of low oil prices, a mild winter (and therefore low demand), relatively high inventories and a minimal decline in gas production continue to add pressure to natural gas prices. These same reasons are also behind the significant price drop for the Transfer Title Facility (TTF – NL), National Balancing Point (NBP – UK) and LNG. As regards TTF, geopolitical tensions between Russia and Ukraine – which would have supported TTF prices –which would have supported TTF prices. Experience shows that a recovery in natural gas prices can develop quickly from the moment a rise in demand is noted. For Henry Hub in particular, the current level of low prices is not sustainable due to higher production costs. In addition, our expectation of an oil price recovery could give some support to natural gas prices. For TTF an upward price recovery would make sense, even within the longer-term downward trend. Nevertheless, it remains very difficult to predict gas prices due to their significant dependence on weather-related events and news.