Drop in oil prices and drivers for the coming weeks

by: Hans van Cleef

Yesterday, oil prices dropped 5% after EIA US crude inventories came in much higher that expected (+8.2 mb vs +1.3 mb exp). The bigger than expected drop in gasoline stocks was completely ignored by the market. Earlier that day, Kuwait’s oil Minister tried to talk up oil prices by saying that compliance of some OPEC members was 140%. This is a sign that other OPEC members are not able/willing to cut production as was agreed in November, in our view. So this is not supportive at all.

Oil prices are currently trading in a narrow range for several months. Yesterday’s decline pushed oil prices to the lower border (see graph below)
We expect a serious test of this lower trading band. A break opens the way to the November 2016 lows (around USD 45/bbl).

Graph: Brent oil first contract trading in a narrow range (x USD/bbl / source: Bloomberg)

The main driver for the coming weeks will be the development of the speculative long positions. Both the non-commercial positions as the hedge funds positioning are at excessive high levels. Yesterday’s move suggest that some of these long positions were closed. Question is how much of these longs were closed by now. Over the weekend new data will be available.

Graph: Speculative long positions are currently at record high levels (x number of contracts / source: Bloomberg)

The other driver for the coming weeks will be speculation on whether OPEC will continue its policy (of lower production) as agreed for H1 2017.

There are two scenario’s:
– First, it is likely that OPEC will continue with this lower production ceiling. (base case scenario) in an attempt to support oil prices. However, higher oil prices will continue to support US shale production.
– The second (alternative/risk) scenario is less likely for now, and that is that OPEC will return to its strategy to fight for market share. In that case OPEC will open the tap and will flood the market with oil again with oversupply as the result. This would add more pressure on oil prices again.

With both scenario’s, we expect the excessive long positions to be reduced, adding pressure to oil prices in the near term. And in the risk scenario, long positions could even be swapped for excessive short positions. In such a scenario, a test of the 2016 lows cannot be excluded.

We will not release a new Energy Monitor in March as all arguments mentioned in our February edition are still in place. Please find this update – including our longer term forecast on oil prices – here: Energy Monitor – Speculation on rising oil price set to ease