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Crude’s cat and mouse game

Crude’s cat and mouse game

TORONTO: Oil markets are in the midst of a rally, heading for the biggest monthly rise in seven years on Friday. Weak dollar, speculation and falling US production have all chipped in.

US output is below 9 million barrel per day (bpd) from the peak of 9.7m bpd seen last April. Meanwhile, production outages from Nigeria to Venezuela have also taken barrels out. And in the meantime, dollar has fallen 6 per cent this year against a basket of other leading currencies.

Speculation is not too far behind. Hedge funds and other money managers have accumulated a record net long position in Brent and WTI futures and options, betting on a further rise in prices equivalent to 656m barrels of crude, Reuters reported.

The net long position has surpassed previous peaks set this time last year (572m barrels) and before that in June 2014 (621m barrels) when Islamic State fighters were racing across northern Iraq and just before prices started to crash. Since the start of 2015, there has been a close correspondence between the accumulation and liquidation of hedge fund positions and short-term movements in oil prices.

Yet despite all this – the question remains – is this sustainable? Fundamentals continue to point to a weaker outlook. Supply is on rise. The Organisation of the Petroleum Exporting Countries (Opec) produced at 32.64m bpd last month, up from 32.47m bpd in March, a Reuters survey said.

At 3.40m bpd, the Iranian output is now within sight of the 3.50m bpd it pumped at the end of 2011 before sanctions were tightened. Iraq, which saw the fastest growth in production in Opec in 2015, also raised its output. Another increase in April came from the United Arab Emirates, following the end of maintenance work on oilfields that produce Murban crude. Also on Friday, Libyan officials said the country’s National Oil Corporation has ambitious plans to restore output to pre-2011 levels after years of violence and disruption.

Hence warning shots were in the air, with some insisting the rally was too soon, and driven in large part by investors taking speculative positions on oil. The colossal net long position has increased the risk of a reversal in prices if the rally was to run out of momentum and hedge funds were to begin liquidating some of their positions.

“This rally doesn’t have strong legs,” said Eugen Weinberg, analyst at Commerzbank in Frankfurt.

“The issue is that we haven’t seen price rallies ... correlate with fundamentals,” Hamza Khan, senior commodity strategist at ING was quoted as saying. “The fundamentals – high stocks, high production – haven’t changed.”

Other analysts in the meantime too, have barely nudged up their forecasts, worrying oil’s recent gains might not be sustainable, Georgi Kantchev reported. Despite the market surge, a survey of 13 investment banks this month saw Brent crude forecasts only up by $1 from the same survey conducted in March. The analysts forecast an average Brent price of $57 a barrel next year, but the same banks were predicting last August that Brent would rise above $70 a barrel this year. Hitting that level has now been postponed to 2018.

“Supply and demand are way out of balance, and if you look at stockpiling, we are floating in oil right now,” Gina Sanchez of Chantico Global said Thursday on CNBC’s Trading Nation.

Some others are warning that 2016’s price moves could follow the same trajectory as last year when a peak in May was followed by a sharp drop. And while the US commercial crude stocks hit a new record last week, with traders pointing to large quantities of unsold crude being held at sea, Norbert Ruecker, head of commodities research at Julius Baer stressed, the US oil output is holding up against expectations, adding: “We see more downside than upside to oil prices.”

If the rally is sustained longer, it could give a fillip to shale and other high price output. This would only exacerbate the issue – adding to the glut and exerting renewed pressure on prices.

The longer term view is distinctly different form the immediate term. Who would have the last hurrah? A cat and mouse game is on. Let’s wait for the outcome.

Published in Dawn, May 1st, 2016

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