crude oil outlook: Crude oil rally hinges on US-China trade deal, Opec output cuts

Crude oil market’s complete focus last month was on the status of US-China trade deal, as positive developments provided enormous support to the prices after both parties assured first phase of trade deal to be signed soon. China also committed to import an additional $40 billion to $50 billion of US agricultural products.

However, the market remained cautious on the prospects of the trade deal. The main issues such as intellectual property and opening up the Chinese financial system to the US banks might happen in Trump’s second term if he wins election next November.

To add to the enthusiasm, market applauded the news where Opec+ was considering making deeper cuts into 2020, with worries over slowing demand growth. Any decision on deeper cuts will likely only be made at the Opec meeting in early December, and so expect plenty of noise between now and then. The key issue for Opec+ is who would be willing to cut output even further.

Market also cheered Saudi Arabia’s move to finally list Aramco on Riyadh’s stock exchange in what could be the world’s biggest initial public offering.

Geopolitical Drama
The geopolitical saga in the Middle East saw risk premium turning to zero or next to $1 as the market ignored various events such as attacks on Iran tankers off the Saudi port in Jeddah, an incident that if confirmed will stoke tension in a region rattled by attacks on tankers and oil sites since May. But all these events failed to boost prices and the attention was shifted back to the demand worries.

Iran remains a big wildcard as US President Donald Trump wants a new Iranian nuclear deal before the US presidential election in 2020. A new Iranian nuclear deal will result in the world being flooded by another 1.7 mbpd. If the sanctions are lifted, oil prices would collapse, as traders doubt Opec’s ability to prevent a glut. And so, US gasoline prices will drop sharply as presidential election gets into high gear, providing Trump with the outcome he wanted: lower gasoline prices and a new and improved nuclear deal that goes much further to securing peace in the Middle East.

Monthly report

Opec and IEA report showed an identical picture of slowdown in demand with Opec reporting that demand for crude to drop from its previous estimate for YoY growth of 1.02 mbpd to 980,000 barrels. The cartel also maintained its projection for 2020 demand growth at 1.08 million barrels. The grouping cut its 2020 demand growth projections by 60,000 barrels in last month’s report. Opec cut its non-Opec supply estimate for 2019 by 160,000 barrels a day to 1.82 mbpd, based on declining US, UK and Norwegian production. The US production was cut by 70,000 bpd in September to 1.8 million barrels.

IEA its oil demand forecast yet again, citing the weakening global economy. IEA predicts that demand will grow by 1 mbpd in 2019 and 1.2mbpd in 2020, both of which are downward revisions by 100,000 bpd from previous estimates. Non-Opec supply could expand by 1.8 mbpd in 2018 and 2.2 mbpd in 2020. Both figures significantly outpace demand growth.

Rig count and inventory

Last month, price were under pressure on account of huge inventory buildup while the drawdown in product stock provided support as the refinery remained under maintenance ahead of winters and the demand for gasoline and distillate saw a huge up rise. Refinery activities saw some strengthening at the end of the month and we can experience a huge drawdown next month as refinery will start working.

The other reason for huge build strong rebound in Canadian imports and another SPR release has encouraged a build to crude inventories. The net imports fell substantially by 873 Kbpd. Low crude imports of 5.8 mbpd were compounded by higher crude exports of 3.7 mbpd.

The sharp fall in US active oil rigs offset fears on weaker demand. The US energy companies reduced the number of oil rigs operating this month by 14, bringing the total to 696, for a record 10th month, the lowest since May 2017 as producers follow through on plans to cut spending on new drilling this year compared to 875 a year ago.

The oil production rose as service firms reported declines in activity, a sign that operators have figured out how to pull more oil from the ground with fewer rigs. The US oil output from seven major shale formations is expected to rise by 74,000 bpd in October to a record high 8.843 Mbpd and US crude production soared nearly to a record of 12.4 mbpd.

Natural gas

Supporting factor for prices was the start of the winter season in the US where the colder forecast for the month boosted the prices. Meanwhile, there are some divergences in weather forecast models, but market is rallying on expectations of huge increase in demand as winter begins. On the other hand, US natural gas stocks have surged during the injection season and are now above the five-year seasonal average for the first time in two years, despite a sharp drop in the number of rigs drilling for gas. Hedge funds and other money managers had amassed a net short position in NYMEX and ICE futures and options equivalent to 1,799 bcf by October 22, close to the largest on record.

Portfolio managers were running more than two bearish short positions for every bullish long position, among the most bearish in a time series going back to 2010. Such extreme short positioning leaves fund managers vulnerable to any extended period of cold weather that forces a fierce short-covering rally. However, we forecast that overproduction is so high and stocks are so plentiful the market will ride through any short-term cold spell.

Conclusion

The Opec+ meet is scheduled in December and the market is once again guessing whether the production cut agreed last December will be extended or deepened.

Russia remains a wildcard as it has a habit of showing reluctance about cuts and this time will be no exception. Russia’s Deputy Energy Minister Sorokin reported that it was too early to discuss deeper cuts.

The other producer, Nigeria has already struck a deal with Opec to allow it to produce more oil against the production agreement. Markets remain nervous as the next question ahead is: how long before other Opec members ask for similar special treatment and if this happens, prices will see huge downfall.

There are at least two Opec members that want to boost their oil production: Iraq and Libya. The market seems to be too over optimistic over trade war deal, and we can expect some upmoves as positive sentiment will drive prices higher, but underneath there remains major questions over Opec cuts and trade deal to happen this year.

(Investors are advised to consult financial advisers before taking an investment calls based on these observations)