Analysis & Profiles 18.5.2016 03:12 pm

Oil price jumps on supply disruptions

Image: Gallo

Image: Gallo

Drawdown in inventory and rebalancing to boost prices in second half.

Unexpected disruptions in production have seen crude oil prices hit six-month highs. While this is expected to set a new floor for oil prices, substantial price increases are only expected as supply tightens in the second half of the year.

A combination of vandalism and sabotage by separatist group Niger Delta Avengers has pushed Nigeria’s oil output down to a 20-year low of 1.4 million barrels per day (bpd) while more than one million bpd of Canadian crude production has been shut down due to raging wildfires in Alberta. Political and financial instability in Venezuela – which has triggered fears of a default by state oil company Petróleos de Venezuela – have also lead to concerns that the country’s oil production, already down by some 188 000 bpd, may fall even further.

Despite these temporary disruptions, some analysts say the global oil market, with high inventory levels, remains oversupplied. “Admittedly, these disruptions are large enough that the rebalancing in the market expected in the second half of the year may already be happening. However, prices could quickly drop back again once at least some of this supply comes back on stream,” said Julian Jessop, head of commodities research at Capital Economics.

Per Magnus Nysveen, a senior partner and head of analysis at Rystad Energy, said the disruptions have only added about $2-$3 dollars per barrel to oil prices. “I don’t think they affect oil prices very much because the market is in oversupply. Oil prices are rising because more and more investors are investing in oil futures,” he said from Oslo. He said investors are taking to oil futures in response to output falling faster than expected in the likes of Mexico, Angola, and China as well as expectations of flat production in Russia.

According to TD Securities Mike Dragosits, oil price gains have also been supported by technical trading. “Technical trading setup talk also seems to be helping the cause, as prices break out to new highs on the year and 50 day moving averages cross above the 200 day moving averages (see chart below), suggesting that more systematic trend following money will likely enter the space,” he said.

oil cross

Source: TD Securities

While a report by investment bank Goldman Sachs, suggests the market may have swung into a deficit as early as May 2016, data from the International Energy Agency, US Energy Information Administration and the Organisation of the Petroleum Exporting Countries (OPEC), which sees slowing production among its rivals, suggests the market will only rebalance toward the end of this year and into 2017.

As rebalancing starts to take effect, Nysveen said ample storage would weigh on prices which are likely to hit $60 per barrel by year-end. Natural declines in production coupled with drawdowns in stockpiles could see prices return to their 2014 highs toward the end of 2017 and early 2018, he said.

Until the market rebalances, gains in the oil price caused by temporary factors may be stymied by a partial reversal in US drilling activity, which current prices support, as well as a hike in interest rates by the US Federal Reserve, Jessop said. “Third, the turn in oil prices removes another excuse for the Fed not to raise interest rates again soon, both by easing the pressure on US producers and by lifting expectations for inflation back above the Fed’s 2% target. Further tightening in US monetary policy – whether next month or later in the year – would be likely to lead to renewed appreciation of the dollar and remove the support that weakness in the US currency has recently provided to commodities in general, including oil,” he said.

Dragosits said disruptions should set a new floor in the low 40s for crude oil prices, heading into the second half of the year.

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