MOFSL

Crude oil was on an upward trend since the start of 2018 and was up about 30 percent from January to October, hitting a four-year high of $86/bbl on increasing fear of market tightness. But the last couple of months turned the tide for crude as prices came down crashing; touching lows of $58 for the Brent, after the US announced change of plans over Iran sanctions.

Prices witnessed a huge correction and continued to fall backed by sharp sell-offs in global equity markets, growing concerns regarding China-US trade tensions and a weaker emerging economies outlook raised worries on global economic and oil demand growth outlook. Huge build up in US crude inventories which have been rising for six consecutive weeks added more pressure.

Bears took control of the market on forecasts of non-OPEC supply growth for 2019 outpacing the expansion in world oil demand, leading to widening excess supply in the market. The main theme was global slowdown due to higher prices which could lead to recessionary situation.

OECD’s interim outlook revised down the outlook for global economic growth from 3.9 percent to 3.7 percent for both 2018 and 2019. The GDP growth in China is expected to remain at 6.5 percent in 2019, as the impact of trade tensions have, so far, been modest.

Meanwhile, IMF was slightly more pessimistic, taking its forecast for China’s growth down to 6.2 percent. Both organisations noted that global trade growth has slowed and that several developing countries have been severely impacted by a decline in the value of their currency.

Some support came in after OPEC clinched a deal with allied oil-producing nations including Russia at its headquarters in Vienna, and agreed to take 1.2 million barrels per day off the market for first six months of 2019. The 15-member OPEC cartel has agreed to reduce its output by 800,000 bpd, while Russia and the allied producers will contribute a 400,000 bpd reduction.

The deal is in line with expectations for the allies to throttle back output by 1 million to 1.4 million bpd. Russia will reduce production by 2 percent from October's output of 11.4 million bpd, equaling about 2,28,000-2,30,000 bpd. OPEC even agreed to exempt Iran, along with Venezuela and Libya. Nigeria, which was exempt under the previous deal, will participate in this round of cuts.

The economic situation of an increase in US interest rates and increasing risk aversion contributed to significant currency depreciation in many emerging markets. Emerging countries that henceforth resisted the re-introduction of subsidies or price controls are now intervening to relieve pressure on consumers. In India, for example, excise taxes were reduced recently to help households cope with rising prices.

The oil market in December has turned from being an oversupply market to being a balanced one after OPEC decision to cut output by 1.2 million barrels. Yet, the markets seem to be bit nervous as the demand for oil still remains lower. The output cut harbors opportunities - but also risks. This is because we might see a price divergence between the price of Brent and WTI and with it a widening of the spread between the two in the course of Q1 2019.

The 1.2mmb/d fails to convince the market that the oversupply is under control. The most important factor will be the compliance for all countries and how Iranian sanction waivers pan out in the next 6 months. For US producers, it provides a lot of clarity for US independent upstream producers going into budgeting season for 2019. The announcement provides a baseline of support of oil between $50 and $55. That's a decent level for US independents.

Inventory levels at Cushing area in the US could rise due to pipeline constraints which prevent oil supply being produced from reaching the main market. Should this happen, the price of WTI is set to underperform Brent. However, eventually this could be reversed if new pipelines resolve the congestion in the Cushing and Permian Basin areas towards Q4 2019.

Brent's calender spread flipped into contango after trading into backwardation for months due to a deep price correction and oil price sell-off, which was concentrated in the front months, in addition to signs of higher oil supply from major oil producers and concerns about oil demand growth. The spread between the Brent and WTI benchmarks widened Q3, to $10.16 a barrel on a continuing increase in US crude oil inventories and supported higher levels of US crude exports.

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Higher US crude oil production and refinery maintenance season in the US added pressure to WTI prices. On the other hand, Brent prices were supported by concerns over potential global oil supply shortages and rising geopolitical tensions.

To sum it up, the process of rebalancing has started following the OPEC cuts and we believe that rebalancing is now well and truly underway. WTI Crude oil price saw the sharpest quarterly fall since 2014 during the quarter wherein it declined more than 33 percent in the period.

The medium-term bias still continues to remain negative as long as below $54-55 range and the current decline could extend towards $44-42 levels. Amidst all the uncertainties surrounding the crude oil market, a decisive move above/below the $55-42 range could lead to extended price action in that direction.

Our expectations are largely on back of consistently lower OPEC supplies during past few months while demand continues to remain weak.

The author is VP- Commodity Research at MOFSL.

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