- Oil prices are still captured between conflicting drivers
- Market speculation will likely trigger volatility: price gains are expected, but conviction is waning
- Over the coming weeks, OPEC will decide on whether it will expand its production cut agreement or not
Market speculators cut their speculative long positions
Although oil prices seem to have stablised in recent months, a significant drop of the oil price was seen in early March. This was the result of the market not reacting to signals from OPEC, which should have been supportive for oil prices. This, together with the lingering high US crude inventories and the rise in US crude production, triggered further uncertainty among investors who had anticipated price gains (long positions). This led, particularly hedge funds, to close a significant part of their speculative long positions, resulting in a sudden price decline.
If we look at the current positioning of both hedge funds and speculative investors, we still see an above average net long position (see graphs above). There is a clear change in trends though. While hedge funds closed their long positions remarkably during recent weeks, speculative investors still believe in a further rise in oil prices. Hedge funds closed the number of outstanding long contracts since mid-February by almost 92,000 contracts. During the same period, the number of short positions (speculating on price declines) gained by over 77,000 contracts. There seems to be several hedge funds which do no longer speculate on higher oil prices, but on lower prices instead.
Speculative investors, represented in the non-commercial positions, also lowered their number of outstanding long positions and raised their short-exposure. However, this switch was not that strong. The net position (long -/- short) shows that these investors still expect a further price rally in the course of the year. As a result, there are still downside risks for oil prices, if this view does not materialize, and investors would have to adjust their positions.
OPEC is still weighing the options: a higher oil price or a higher market share
The production cut agreement of several OPEC members, complemented with a few non-OPEC oil producers, will expire at the end of June. The next official OPEC meeting will be in Vienna on the 25th of May. During that meeting, the official decision will be made whether OPEC will, or will not, expand their agreement to lower crude production. However, in the course of April and May, several informal meetings will be scheduled. During these informal meetings the future of the agreement will also be discussed. Signals will reach the market and investors will accordingly react on these signals suggesting in which direction OPEC is thinking. We expect a continuation of the production cut agreement. Especially if non-OPEC countries – like Russia – agree to contribute as well by lowering their production ceilings, the market will be likely heading for a balance between supply and demand. This could result in, and would justify, a higher oil price in the second half of this year.
The main question is what OPEC will decide. On the one hand, it seems logical to assume that OPEC will expand the agreement to prevent triggering a large drop of the oil prices. After all, oil prices gained significantly in the course of 2016 ahead of this production cut agreement on the back of market expectations. If the OPEC would decide not to continue its current policy, the market would immediately start to price in a new situation of lingering oversupply. This would again increase the pressure on oil prices.
On the other hand, the risk that OPEC would not expand the agreement has increased, even despite the possible negative effects for oil prices. Oil prices gained less than expected in Q1 2017. And the gains we saw in 2016 triggered a solid recovery of the US crude production. The higher oil production in the US, and the lingering high US crude inventories result in a shift of market share from OPEC to non-OPEC (mainly US) oil producers. On top of that, this situation creates a ceiling on oil prices.
Record level of US crude supplies keeps investors worried
The weekly US inventory data keeps investors’ sentiment at the edge. The US Energy information Administration (EIA) data show a record level of US crude inventories. As a result , not only should oil production drop, but also the level of inventories. However, with current high level of inventories, combined with the rising oil production, finding a balance between supply and demand is once and again pushed further in time.
A remarkable reaction was noted after the release of the weekly API data on 4th of April. The outcome showed a sudden drop of crude inventories. As the market is still positioned for a further price gain, the market reacted strongly on the number and pushed oil prices higher with several percentage points.
Nevertheless, we should not only give weight to one surprising figure, but keep in mind on the long term trend. This trend indicates that US crude stocks are still above average highs and there has not been any structural change of the trend (see graph above).
Most important drivers for Q2 2017
All in all, there seems to be limited upside for oil prices in the near term. Nevertheless we kept our Brent and WTI oil price forecast for the end of 2017 at USD 60/bbl. We expect that oil prices will remain captured between supportive pressure on oil prices as a result of the OPEC production cuts, and downside pressure due to higher US crude production during the coming months. Therefore, the market focus will remain on oil supply and not necessarily on oil demand. Oil demand will continue to show a moderate growth due to continuous global economic growth.
Over the coming weeks, OPEC will decide on how it will expand its production cut agreement . In the mean time, uncertainty in the market may trigger higher volatility . Therefore, OPEC would largely benefit from a clear communication towards the market. The main challenge for all OPEC-members and the joining non-OPEC oil producers – especially Russia – is to speak with one voice. The influence of weekly inventory data can be significant, especially if the data show a decline in inventories (either crude oil, and/or gasoline supply). As long as the market still has a net long position, price supportive events may have a bigger impact that opposite signals.
For the end of the second quarter, we expect an oil price (both Brent and WTI) of USD 50/bbl. An oil price recovery can still be expected during the second half of the year. This is mainly based on a weakening of the US dollar and the (expectation of) decline of the oversupply of oil (both production and supply). In the longer term, more support can be expected due to declining investments in the oil sector.
The main risk to the base case scenario described above is a change in OPEC policy. If the OPEC decides to adopt a strategy to regain some of its lost market share, the risk scenario will be leading. In this risk scenario, a significant drop of oil prices – comparable with the situation in 2014/15 – will be on the cards. Please see table 1 for our base cast forecast.