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Oil Market Report - December 2017

EXECUTIVE SUMMARY

Crude oil price has ended the year on a very high note. WTI and Brent benchmarks have got to 2015 maximum levels ($62.5 for WTI and almost $70 for Brent). Technically it looks supported by breaking through key resistance. Brent surpassed its resistance earlier than WTI in September instead of November due to hurricane season effect.   

OPEC looks harmonious and united for the moment. The faith in their cutting deal with non-OPEC export countries like Russia and Mexico is quite strong. It reflects on money manager’s net long position in crude oil futures, which is currently at the record high. Saudi Arabia has made a very good work last year by keeping compliance level close to 100%. What’s more, after discussion with commodity hedge funds managers Saudi Arabia energy minister tried to limit and include monitoring of export volumes in the oil production cut deal in the second half of the year.

Fundamentals are not such supportive. Storage levels have been considerably drawn down in OECD countries in 2017, but there is still much to do for OPEC to come into balance. There are plenty of downside risks for the price:

  • Growth in India oil demand was relatively low just at +2% year-over-year comparing to more than 10% in 2016.

  • There are constant concerns regarding China demand due to potential end of crude oil strategy stocks building program.

  • Last year in the first quarter there was a surprisingly weak demand for crude oil in the world in general.

  • U.S. oil production must have been as high as 10 mln bbl / d by the end of 2017 according to Rystad Energy assessment and it may easily achieve 11 mln bbl / d by the end of 2018, surpassing Russian level of oil production as well as Saudi Arabia’s. Current crude oil price above $60 per barrel should be very favorable for U.S. shale producers to raise its level of activity.

  • China, by far Asia’s biggest oil consumer, is now producing so much fuel that its refiners have turned to exports to find buyers. According to Reuters, Chinese diesel exports have surged by almost 3,000 percent since early 2015, to a record of more than 2 mln tons last December. Its gasoline exports are up by 365 percent since early 2015, to more than 1 mln tons in December.

  • Singapore refining margins, which act as Asia’s benchmark, have slumped by 90 percent from their 2017 high, to below $6 per barrel this week – the lowest seasonal level in five years.

  • Feeling the pinch from mounting competition and the pressure from refiners, OPEC’s No.2 and No.3 producers, Iran and Iraq, cut their crude oil prices this week to Asian customers.

Geopolitical risks are significant on the other hand:

1)      The suspension of Iran nuclear deal is obviously the key risk. President Trump has promised to renegotiated or exit from the deal. It is a long and complicated matter to invent a better suggestion. So there is a high risk of Trump to lose his patience and just quit the deal. In this case Iran could have a problem again to export about 800 thsd bbl /d of crude oil volumes. It is almost the scale of all oil production return in Libya last year.

2)      Venezuela is another significant risk. Probability of sanctions against the regime does not look substantial, but dramatic underinvestment in oil production, refining and production might provide a further plunge in export volumes from the country.

The balance of risk to the price looks strongly skewed to the downside though. Geopolitical risks could bring a lot of volatility but in the end current crude oil prices are seemingly too high given still quite weak market fundamentals.

Additionally, CEO of Russian company Lukoil said that if oil prices remain at $70 per barrel then Russia should start exiting OPEC+ deal smoothly to avoid repeating mistakes of previous years when oil prices were over $100 per barrel. However, Minister Al Mazrouei of UAE sees no need to panic and anticipates oil services firms' prices to rise and slow shale growth in 2018. “We don't look at the price in a day and say we are in a point where we need to do changes. We need to give the market time.”

Some OPEC deal’s participants may quietly raise their output given current attractive prices. Kazakhstan, for an instance, has already surpassed its quota for more than 100 thsd bbl / d. Other countries could also be more eager to risk upsetting Saudi Arabia.

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