Expect volatility as Opec challenges shale on the supply front

The oil markets are in a phase of renewed imbalance rather than re-balance, writes Hussein Sayed

The IEA anticipated US sanctions to drive Iranian barrels out of the market. Photo: AP

The middle of 2018 is meeting the end of 2014. That’s the last time the oil markets saw spot Brent Crude prices at the level of just under $80 (at the time of writing). The trend appears to be a return to pre-crash prices, at least from a bullish point of view. The question is, do the fundamentals of supply and demand support this perspective?

There are several drivers behind the current situation in the oil markets. Opec’s recent meeting in Vienna confirmed investors’ impressions that the supply taps would be turned back on. But - and it’s a big but - the bulls are not convinced that enough supply can reach the markets quickly enough to cover the shortfall from Iran and Venezuela.

The EU and UK may be diverging from US sanction policies on Iran, nonetheless the dampening effect of Donald Trump’s renewed economic pressures cannot be denied. Oil markets anticipate a shortage of two million barrels per day. Opec’s adjusted output deal is for Kuwait, Russia and Saudi Arabia to ramp up an extra 1 million bpd, leaving a potential shortfall of 1 million bpd for the short term. The bulls may be taking a bet that increased demand will outstrip supply over the next few months, driving the price up as a result. In other words, speculation may override the facts of demand and supply until the next definitive benchmark releases by the US' Energy Information Administration and Opec in July.

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At the geopolitical level, upcoming mid-term elections in the US are putting Mr Trump in the hot seat amid rising petrol prices. Ever since the 1970’s oil crisis, high fuel prices have been a significant trouble spot for the politicians in charge at the time. West Texas Intermediate prices may be relatively lower than Brent Crude, but consumers in the US will not take kindly to being out-of-pocket at the petrol station.

Mr Trump’s sanctions on Iran may have a boomerang effect on his popularity come November and he is aware of this judging from his tweets about Saudi Arabia agreeing to increase supplies. US shale may be steadily increasing its output, but US inventories show a big difference between the week ending June 22  and the equivalent period in 2017.

Stocks for the period in 2018 were at 425,352 (thousands barrels) compared to 509,203 in 2017. That’s not scraping the bottom of the barrel by any means; still, it’s a trend to take into consideration given that Opec has decided to challenge US shale on the supply front. Let’s remember that the US has increased its exports of crude oil and reduced its imports, meaning that in the case of a supply shortage over the next few months, Mr Trump’s policy of protectionist energy independence may be impacted by reduced US stocks and rising WTI prices.

It appears that the oil markets are in a phase of renewed imbalance rather than re-balance. Opec’s price range target of $55 to $65 for 2018 has been overshot on the back of Iran and Venezuela’s woes and US sanctions. It’s going to be an expensive campaign for Opec plus Russian producers to match US production and output levels at such a fast pace, so clearly investors have their work cut out for them to anticipate the next movements in Brent Crude spot prices.

In the case that benchmark prices keep rising and supplies/inventories falling, we could see Brent trading in a range of $70 to $80 per barrel in the third quarter. The alternative scenario is that supplies from US shale and Opec producers come through faster than expected, meaning Brent may trade in a range of $65 to $75 per barrel in the short term. Given the current complexity, either scenario is possible at this point, and I continue to expect volatility in the oil markets over the next few months.

Hussein Sayed is the chief market strategist at FXTM