Oil prices faltered at the start of the second week of the year, as fears
set in about a rapid rebound in U.S. shale production. For the better part
of two months, optimism surrounding the OPEC deal has buoyed oil prices, but
bullish sentiment from speculators are showing early signs of abating, raising
the possibility that the oil rally is running out of steam.
WTI and Brent sank more than 2.5 percent in intraday trading on Monday, after
a report at
the end of last week showed another solid build in the U.S. rig count, the
tenth consecutive week that the oil industry added rigs back into the field.
Aside from a single week in October, the U.S. oil industry has deployed more
rigs in every week dating back to June, a remarkable run that has resulted
in more than 200 fresh rigs drilling for oil. The gains in the rig count come
even as oil prices have held steady in the mid- to low-$50s per barrel.
At the start of 2017, there are two major dynamics at play occurring at the
same time, each pushing in opposite directions on the market. The OPEC deal
is slated to take oil off the market, while U.S. drilling is expected to add
new supply. The pace and magnitude of each trend will ultimately drive oil
prices one way or the other.
On the positive side of the ledger, there are early signs that OPEC members
are meeting their commitments. Saudi Arabia said last
week that it is lowering its production in January by 486,000 barrels per day,
a volume that it promised to cut as part of the November deal. That will take
output down to 10.058 million barrels per day, a level that Riyadh was only
required to meet as an average over the January to June time period. Cutting
to that level ahead of time is a sign of good faith from Saudi Arabia, and
increases the chances that OPEC will stay true to its promises.
On top of that, Kuwait's envoy to OPEC said that Qatar, Kuwait and Oman were
also complying with the cuts. In an interview with
Bloomberg, Kuwait's Nawal Al-Fezaia said that those countries already told
customers that cuts were imminent. "It's a good time to do maintenance on oil
fields during production cuts," Al-Fezaia said, noting that Kuwait will lower
output from 2.89 mb/d in December to 2.7 mb/d by the end of January.
Market analysts paused a bit on news that Iraq's oil exports from its southern
ports on the Persian Gulf hit a record high in December, but the data has no
bearing on whether or not Iraq will comply with the agreed upon cuts. "Achieving
this record average will not affect Iraq's decision to cut output from the
beginning of 2017," Oil Minister Jabbar Al-Luaibi told Bloomberg in an emailed statement. "Iraq
is committed to achieving producers' joint goals to control the oil glut in
world markets."
It is still early but all signs point to a stronger commitment from OPEC to
adhere to the specifics of the cuts than market analysts might have given them
credit for. That bodes well for a narrowing supply surplus – and ultimately
a deficit – as well as falling inventories. In other words, OPEC is succeeding
in putting upward pressure on prices.
However, the flip side of the equation is faster drilling from the U.S., where
rig counts continue to climb. Oil output, according to EIA weekly surveys,
is up roughly 300,000 bpd from summer lows, with more supply expected to come
online in the months ahead as drilling picks up pace.
It is unclear, at this point, how rising U.S. supply and falling OPEC output
will ultimately balance out. For now, the consensus seems to be tightening
conditions in the first half of 2017, with much greater uncertainty in the
second half, but that remains to be seen.
What is clear is that oil speculators have built up such a large bullish bet
on oil that they have opened up crude to near-term downside risk. According
to Reuters,
hedge funds and other money managers amassed net-long positions in WTI and
Brent equivalent to 796 million barrels in the last week of December, which
was nearly double the amount from mid-November. The OPEC deal clearly fueled
a huge speculative rush in rising oil prices, which, not coincidentally, corresponded
with real gains in crude prices.
But at this point, there are very few short positions left in oil, while a
massive volume of long bets have built up. That suggests two things, both of
which are bearish for oil: there is not a lot of money left to go long, lowering
the chances of further prices gains; and the potential for a correction in
prices is very high at this point. Indeed, in the most recent week for which
data is available, net-long positions declined a bit, raising the possibility
that bullish bets have peaked. All it will take is a bit of bearish news to
spark a downturn in prices.
There are a few minor worrying signs for oil prices that could crop up as
additional bearish forces in the next few weeks. The U.S. DOE announced on
January 9 a "notice of sale" from its strategic petroleum reserve, with plans
to sell 8 million barrels for delivery over the course of February, March and
April. Meanwhile, Libya is seeing rapid gains in oil exports after the reopening
of a key export terminal, with output jumping to
700,000 bpd, according to the latest data, up sharply from the 580,000 it produced
in November and the 300,000 bpd it exported before it started restoring output
last summer. Moreover, Nigeria – which, like Libya, is exempt from the OPEC
deal – is intent on restoring production. It may struggle to do that with the
recent shuttering of
the Trans Niger Pipeline, potential strikes from
oil workers unions and the announcement from
the Niger Delta Avengers that attacks will resume this year. In fact, production
appears to have declined in December, falling 200,000
bpd to 1.45 mb/d, becau se of some of these issues. But if those problems can
be overcome, Nigeria has latent production capacity that could come back online
at some point.
And in a sign that there is not a lot of room on the upside, a kerfuffle in
the Persian Gulf over the weekend did nothing to affect oil prices. A U.S.
Navy destroyer fired three warning shots towards Iranian ships, an incident
that in the past would have led to a sharp, even if brief, rally in crude prices.
Instead, the markets shrugged off the incident – WTI and Brent sank on the
first trading day after the event, on unrelated news. "The market is overbought
and under a lot of downward pressure," Bob Yawger, director of the futures
division at Mizuho Securities USA Inc., told Bloomberg. "The
shots fired at the Iranian boats in the Strait of Hormuz didn't do anything
to the market. A few years ago that would have added a couple dollars to the
price."