March 16, 2017

Crude Likely to Hit $60 in 2Q

Stratas Advisors

This excerpt is from a report that is available to subscribers of Stratas Advisors’ Short-Term Price Outlook, Executive Dialogue, Global Energy Perspectives, and Financial services.

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Crude’s latest decline has thrown the market into a mild panic. Higher than expected inventories combined with bearish commentary from the Saudi oil minister last week have cost crude prices roughly 10% since March 8.

If nothing else, the last five trading days have reflected a psychologically fragile oil market. With all of the current geopolitical unknowns, it appears traders remain concerned that data reflecting seasonal moves may be the indication of more structural trends. Combine this with any rumblings that OPEC may not extend cuts past May 25th, and market sentiment remains extremely volatile despite a record number of long positions in the crude market.

In our latest Short Term Outlook, Stratas forecasted 1Q2017 average Brent price of $53. Up through March 14th, the average for fourth quarter has actually been tracking $2 above our forecasted 1Q average at $55. With 15 days left in the quarter, we expect our price forecast to land within $1.00 of the actual quarterly average. 

The market remains hyper-focused on US inventory levels, but this number only tells part of the story. As US production has ramped up, refinery runs hit their lowest levels since October 2015. Based on seasonal trends, these stock builds are likely to continue for the next several months as global demand dips. But demand and refinery runs will rebound late in the second quarter, absorbing supply excess and begin draws on crude inventories.

Even with builds in the short term, we believe that the supply/demand fundamentals will be supportive of crude prices. Weekly data out of EIA indicates some potential weakness from gasoline, but we think this is more of a statistical anomaly and not from structural factors.

Consequently, we are forecasting that US gasoline demand will pick up in late Q2. US diesel demand is getting stronger, supported by a pickup in industrial activity – including rig activity from the US shale patch. Europe is seeing strength in inflation and industrial output – so much so that the European Central Bank (ECB) is looking more likely to slow down its bond-buying program (quantitative easing) and potentially raise interest rates. This remains relevant not just for demand but it also reflects potential downward pressure on the dollar if monetary policy shifts in Europe.

The bottom line: Our analysis of data indicates that demand remains on-track with a demand forecast of 1.4 Mbpd for 2017.

With respect to the supply-side of the equation, the market has shown concern about the rebound in shale-related activity in the US.  The current trend of overall supply, however, is consistent with our expectations. OPEC’s level of compliance with the agreed cuts is higher than what is in our reference forecast (94% vs 60%). The higher level of compliance by OPEC is partially offset by Russia only reducing production by 100,000 bpd (in comparison with the agreed reduction of 300,000 bpd). Going forward, we expecting that compliance might slip some, but still will stay about the effective level of 60%. 

The one major risk pertains to the extension of the OPEC production cuts passed in May. Some believe that the Saudis could once again flood the market in an attempt to finish off shale producers once and for all. But this is not likely. Most OPEC nations will be hard-pressed to bear another major drop in prices, while previous attempts at crashing the market have been demonstrably unsuccessful in taking down larger shale operators. Extension of the cuts – at least through the end of 2017 - remains the Stratas base case.  

But, uncertainty remains. OPEC compliance and strategy, Russian production levels, elections in Europe, geopolitical tensions in the Middle East, nuclear actions by North Korea, lack of clarity around US trade and economic policy, and the future of global interest rates are all potential sources of volatility. We are still holding, however, to our forecast that the price of Brent crude will see $60 in the second quarter. 

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