Is The Oil Price Rally Over?

Proshare

Thursday, August 02, 2018 /09:10AM / FDC

Background

Since the month of March, oil prices have embarked on a three-month bullish streak, rising 19.5% to reach a 3½ year high of $79.44pb on June 29th. This was driven by four main events: i) the US- China Trade war, ii) US-Iran Sanctions, iii) declining US inventories, despite the 13.45% increase in rig count, and iv) dwindling global supply, as a result of lower output from Libya, Venezuela and Canada.

Since then, prices have lost 8.5% to $72.69pb as at July 20th. This turn-around of events was primarily caused by sup-ply factors.

First, in accordance with its decision on June 29th in Vienna, OPEC and its allies have reduced compliance levels. Compliance rates fell to 120% in June, from a high of 147% in May and 181% in April. The oil bloc appears to be hearkening to President Trump’s tweet for a call for lower prices.

Secondly, in the week ending July 13th, the US output reached a record high of 11mbpd (the highest in history). Ad-ditionally, Saudi Arabia’s output jumped 5.4% to 7.6mbpd – the highest monthly increase since 2016-end.

Factors that will affect short-term prices

Just like any other commodity, the price of oil is influenced by the market forces of demand and supply.

OPEC and its allies plan to reduce compliance to 100%. This is equivalent to an addition of 1mbpd to the mar-ket, compared to April. However, in reality this figure could be as low as 700,000mbpd, due to the lack of spare capacity. Spare capacity refers to the ability of oil producers to ramp up production in response to global supply disruptions. At the moment, most oil rich countries, with the exception of Saudi Arabia, are al-ready producing close to maximum capacity.

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Nevertheless, OPEC production is expected to continue to inch up in the coming months. Likewise, Canada’s Syncrude is expected to resume operations by first week in August (latest). For Libya, it is less straightforward. After the resumption of the National Oil Corporation’s (NOC) exports, and the re-opening of El Feel oil field in early July, another major oil field has declared force majeure following the kidnapping of two staff. Political and military division would continue to pose threats to Libya’s output in coming months.

US President Trump has issued a deadline of November 4th, to its allies to completely stop the importation of Iranian oil. Iran’s biggest importers include China, India, South Korea and Turkey. If these countries comply, this could potentially mop up approximately 1mbpd from the global market. Nevertheless, comments from China and India have suggested that they may not be quick to take the US’ side. Meanwhile, Iran has taken the US to the International Court of Justice on the grounds that Iran has abided to the rule of law, and thus such sanctions against it are unlawful.

The jury is out as to what the allies will do in the coming months. Until then, the suspense around the sanctions would keep market expectations bullish. This will partially balance out the effect of higher global supply from OPEC and its allies, the US and Canada.

Given these considerations, we expect the price of oil to dip further by 1%-3% to an average of $70pb-$72pb in the short term (4-8 weeks).

Implications

At $70pb, oil prices would be 5.3% higher than the price at the beginning of the year, and 40.85% higher than prices a year ago.

Also, this price level is 30.77% higher than the budget benchmark of $52pb, and is still sufficient to support fiscal spending, with enough leeway for national savings. Thus, Nigeria’s trade balance would remain in surplus territory, as export earnings remain relatively robust. These earnings would also be able to support the external reserves, the naira and the ongoing recovery process.

 


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