By Nick Cunningham
After declining by more than 20 percent from the October peak, oil prices are showing some signs that they have now bottomed out.
WTI hit a low point at $56 per barrel recently and Brent hit a low just below $65 per barrel. Both crude benchmarks regained some ground at the end of the week, despite the huge increase in U.S. crude oil inventories. In fact, rising prices in the face of the 10-million-barrel increase in crude stocks suggests that oil may have already hit a bottom. “[Y]esterday’s price reaction to the US inventory data shows that negative news is now largely priced in,” Commerzbank said in a note. “This is the only way to explain why an increase in US crude oil stocks of a good 10 million barrels failed to put further pressure on prices.”
At the same time, crude stocks have now climbed for eight consecutive weeks, surely a sign that the market is decidedly back in a surplus situation. That is bearish, to be sure, and helps explain the collapse in oil prices over the past month.
But it also significantly increases the odds of a response from the OPEC+ coalition in early December. “[W]e believe oil is oversold and will likely bounce up from the current levels, as OPEC+ dials back production in December,” Bank of America Merrill Lynch said in a note on Wednesday. The bank said that it no longer sees Brent rising to $95 per barrel next year, as it previously thought, noting that “oil bulls have capitulated and so have we.”
However, the liquidation of net-long positioning by hedge funds and other money managers has taken a lot of pressure out of the market. As a result, there is more room on the upside once again. “[T]he oil market is a lot cleaner now from a positioning standpoint. Given that inventories are still not too high, we believe oil prices should find some support from a fundamental perspective,” BofAML wrote.
Barclays pointed to some fundamentals to suggest that things aren’t as bad as they seem. For instance, OECD stocks in terms of “days of demand cover,” remain below the five-year average. “Based on our balances, we expect the amount of inventories in the OECD on a days of demand cover basis to remain supportive of prices through the end of next year,” Barclays said in a note.
Moreover, the waivers on Iran sanctions are temporary, and even though the U.S. was more lenient than expected, Iran should continue to lose exports in the months ahead. Indeed, the recent price crash actually gives the Trump administration a lot more room to work with, and it can take a harder line with the eight countries it granted waivers to the next time around.
Finally, lower prices could shut in marginal supply and stimulate demand. Barclays even suggests that Iran may step up threats on the Strait of Hormuz because of lower prices, while Venezuela might lose output at a faster rate.
Still, a price increase from current levels hinges on action from OPEC+. Saudi Arabia has already signaled that it intends to lower exports by 500,000 bpd in December, and that further action might be forthcoming from OPEC+. Russian officials told Reuters that they are not enthusiastic about the 1.4-million-barrel-per-day cut that was reported in the media, but that they might sign on to something more on the order of 1 mb/d.
These rumors tend to drive the market and the price gains seen on Thursday and Friday may have been somewhat driven by rising expectations of OPEC+ action. As these things go, oil traders buy and sell on the rumor. More specifically, the 500,000-bpd Saudi cut is already being priced into the market, and the potential 1-mb/d cut from OPEC+ collectively is now increasingly being factored into the market as well. Because there are now rumors of a cut as large as 1.4 mb/d, the 1 mb/d option could take on a “middle-of-the-road” option. Anything less will be a huge disappointment and could drag oil prices back down.
The IEA noted that the global supply surplus could rise to as much as 2 mb/d in the first half of 2019 based on the trajectory of the current fundamentals. It will require OPEC+ action to head that off.