Oil hits turbulence on Syria flare-up, but consolidation may be taking hold
By Navneet Damani
Oil prices rallied in the previous week and touched highs not seen since December 2014, underpinned by greater geopolitical uncertainty in the Middle East and heightened concerns over military action of Western powers.
OPEC and IEA monthly release stated that global oil stock surplus is close to evaporating, citing healthy energy demand and supply cuts while revising up forecast for production from rivals that have benefited from higher oil prices.
The potential fallout from a US-led military strike in Syria will likely be the main driver of sentiment in the oil market in the week ahead. The United States, Britain, and France pounded Syria in a coordinated air strike on Friday night, in response to alleged chemical weapons attack believed to be carried out by forces aligned with the government of Syrian President Bashar Assad in Douma, a town that was held by Syrian rebels.
The record high prices of oil came even as American crude supply unexpectedly increased and US crude production continually reached newer highs. Also, contributing to oil's geopolitical risk premium was the Saudi-led invasion of Yemen. Yemen's Houthis have targeted Saudi oil, including launching a drone strike on a facility owned by the country's oil giant and attacking a Saudi oil tanker.
Crude prices tallied their best weekly performance in eight months last week, driven by fears of a US-led military conflict in Syria. While Syria is not a significant oil producer itself, the wider Middle East is the world's most important crude exporter and tension in the region tends to put oil markets on edge.
A measure of oil-price volatility also jumped this week on speculation that rising conflict in the Middle East may hinder crude output and shrink global supplies, sending prices above Januarys highs. At the same time, concerns persist that surging US production will dampen efforts by OPEC and its allies to tighten the market and prop up prices.
OPEC in its monthly report stated that its oil output fell to the lowest in a year last month amid reduced supplies from Venezuela and Saudi Arabia, suggesting that global markets may tighten sharply later this year.
US Treasury Secretary Steven Mnuchin signalled that the nation may impose strong sanctions on Iran as Trump seeks to renegotiate a multinational accord that curbs the Islamic Republics nuclear programme which will further support the rally.
One more factor that added to the bullish sentiment was the continuous decline of crude oil production in Venezuela. Production continued to decline in March to 1.5 million bpd and volume shrank by 77,000 bpd with respect to February.
IEA in its monthly report stated that those stocks in developed countries could fall to their five-year average – a metric used by OPEC to measure the success of output cuts, as early as May. IEA reported that even though non-OPEC output was set to soar by 1.8 million bpd this year on higher US production, it was not enough to meet global demand, expected to rise by 1.5 million bpd or around 1.5%.
Sentiment turned bearish after Baker Hughes reported a 7-rig increase to the number of oil and gas rigs this week. Drillers added seven oil rigs in the week to April 13, bringing the total to 815, the highest since March 2015. More than half the total oil rigs are in the Permian basin in west Texas and eastern New Mexico. Active units there increased by one this week to 445, the most since January 2015.
The US government expects oil output in the Permian space to rise to a record high near 3.2 million bpd in April, about 30 per cent of total US oil production. The US rig count is much higher than a year ago when 683 rigs were active.
For most of 2018, the front-month WTI contract has remained in a state of backwardation. We expect this choppiness to continue in the oil markets for some more time. The factor that could drive the market into bearish mode is any failure in the ongoing negotiations between the US and China which will likely make President Trump follow-through on his threat to impose sanctions on the communist country.
This could be potentially bearish for crude oil. If there is a compromise and stocks rally, then look for crude to be underpinned.
For the week ahead, geopolitical worries will remain the prime concern that will drive crude oil prices. We expect crude to consolidate in coming week ahead of deterioration of risk between US-Russia relationships, which led prices to its multi-year highs.
Ongoing efforts by major global crude producers to reduce a supply glut and indications of a steady increase in US output levels will also stay on the agenda. In the week ahead, oil traders will await fresh data on US commercial crude inventories on Tuesday and Wednesday to gauge the strength of demand in the world's largest oil consumer and how fast output levels will continue to rise. Comments from global oil producers for additional signals on whether they plan to extend their current production cut agreement into the next year will also remain at the forefront.
Technically, short-term bias looks to be in a broad range between Rs 4,460-4,270 and a break below 4,270 looks negative and the decline could extend towards 4,130.
(Navneet Damani is AVP Research at Motilal Oswal Commodities. Views expressed in this article are author's own and do not represent those of ETMarkets.com)