Outlook remains bearish for crude oil

WTI crude oil had a better run in the first quarter than expected as geopolitical risks took centre stage and a sharp fall in Cushing inventories further aided the uptrend.

Supply side factors are expected to underpin prices. Supply side picture continues to improve especially with Iraq coming on board with record production. The global balance still favours the supply side but risk premium owing to uncertainty over the relations between the West and Russia has kept prices firm.

US production remains high but a new pipeline, which helped Cushing inventories drain much faster, has supported prices to a large extent. Hopes of supply resuming from Libya have faded and fresh violence in South Sudan and Nigeria has added to the problems.

However, OPEC supplies breached the 30 million barrels-per-day-mark (bpd) led by a surge in Iraqi output to 35-year highs.

On the inventory side, OECD total oil inventories dropped to 2.58 billion bpd and average US inventories in the first quarter were 364.1 million barrels – 3.8 per cent lower quarter-on-quarter and 2.8 per cent lower year-on-year as unusually cold weather in North America drew stocks of heating fuels.

Russian worries Overall, WTI prices averaged $98.6 in the first quarter, one per cent higher compared with the fourth quarter of 2013. The ongoing conflict between Russia and Ukraine has resulted in additional risk premium in oil prices.

Russia annexing Crimea and the possibility now of other eastern States breaking away from Ukraine are keeping oil prices higher.

The conflict has increased the friction between the Western powers and Russia. While sanctions have already been imposed on Russia, nothing in the current sanctions is likely to have any direct impact on energy flows from Russia.

It remains to be sees how the sanctions will impact trade with Russia eventually but the nervousness in the energy markets is evident, given that Russia is among the world’s biggest oil and gas producers.

Russia currently produces 10.5 million bpd of oil and, in terms of exports, is the world’s second-largest net oil exporter. Total net oil exports are around 4.3 million bpd.

If exports are affected, they could far exceed Saudi/OPEC spare capacity of around 2 million bpd. In 2013, Russia exported 3 million bpd of crude oil to OECD Europe – 36 per cent of its net oil imports.

While our base case scenario is that sanctions won’t affect the energy trade, it is unlikely that risk premium will fade off completely in the near-term.

Additionally, disruptions in vital oil producing countries such as Iraq, Nigeria, South Sudan and Libya have been eating sharply into the global spare capacity buffer.

Overall, oil outages stand close to 3.25 million bpd. Looking at the overall supply picture, non-OPEC production growth continues to outpace OPEC supply growth, driven largely by the surge in US domestic production.

On the demand side, we continue to expect demand growth to be outpaced by supply. Amid expectations of a recovery in developed economies, Chinese data continues to point to lacklustre growth.

Oil demand in China during the first quarter was 9.96 million bpd, down 0.6 per cent year on year, marking the first contraction in first quarter oil demand since 2008.

Inventories For WTI crude, the inventory dynamics have undergone a shift with Cushing inventories declining sharply and Gulf coast inventories surging to record highs.

Inventories at Cushing, which is the delivery pint for WTI decreased from 39.6 million barrels at the end of last year to 27.2 million barrels by the end of the first quarter.

Cushing inventories currently stand near 24 million barrels, a five-year low and almost 50 per cent below year ago levels and 30 per cent lower than the average for the first quarter.

Price forecast In terms of price outlook, we maintain a bearish outlook for crude oil going ahead but geo-political risk, more specifically the situation in Ukraine and lower OPEC crude output is likely to keep prices supported in the short term.

Global crude oil supply is picking up and weather led demand growth in the first quarter is likely to ease as we go ahead. On the downside, there is a strong possibility of prices falling below $95. The upside risks from geopolitical factors always remain but we expect such upside rallies to be short lived.

In the domestic markets, prices can fall up to ₹5,600/5,500 levels in the medium term.

(The writer is Associate director Head – Commodities & Currency, Motilal Oswal. Views are personal)

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