Oversupply persists in oil markets

Oil, as an asset, has gained charm in recent weeks with prices rising for the second month in a row.

WTI and Brent have gained by around 11.5 per cent and 10 per cent, respectively, in April till date. In March, they were up by around 13.6 per cent and 10.09 per cent, respectively, indicating increased investor interest in the asset class.

However, it’s not all rosy, although March marked the market’s best quarterly gains since mid-2015. Many believe that the rally could fade soon if the major crude exporters go in for an output freeze.

Market watchers believe that the rebound in US crude from the 12-year lows touched in February was due more to short covering rather than improving fundamentals.

The April 17 meeting in Doha, between the Organisation of the Petroleum Exporting Countries (OPEC) and other major suppliers, including Russia, did not result in any output freeze.

Although the main aim of the producers was bolstering prices, the hopes of investors across the globe were not met.

Oversupplies still persist in oil markets due to resilient US production, high OPEC output, led by Saudi Arabia and Iraq, and the gradual return of Iran since Q1 of 2016.

A tentative agreement among the world’s largest producers to keep oil output at January’s levels has barely made a dent in global supplies. Rising crude inventories continue to bother oil markets.

Since the start of winter in the US, actual inventories have grown by leaps and bounds. Crude inventories as on April 1, stood at around 536.5 million barrels, compared to 460.997 million barrels as on October 2, 2015.

The rise in inventories clearly suggests that the incremental demand for crude oil is lacking. Hence, the positive momentum is not likely to continue for a longer period.

Saudi Arabia needs a barrel of oil to fetch $85 to finance its public spending and $60 to keep its current account balance. America has sustained production at over 9 mbpd, despite a sharp fall in the number of oil rigs, suggesting that shale firms are becoming more efficient.

Hence, oil prices have to rise for Saudi to maintain its budget balance; whether US producers remain in business or not is a secondary question.

The rout in the sector continues with OPEC’s reluctance to cut its oil output despite falling prices. The absolute rise in crude inventories in the US is a cause of concern for oil markets as it remains the highest. The speculative behaviour in oil markets, however, suggests that hedge funds and money managers are bullish on crude oil prices. As on April 12, money managers are net long in crude at 205,139 contracts compared to net longs of 63,175 contracts on Feb 23.

From a three-month perspective, we expect WTI oil prices (CMP: $39/barrel) to trade higher, towards $47 and Brent (CMP: $41.72/barrel), towards $49. On the MCX, oil prices (CMP: ₹2,602) can move higher towards ₹3,100 a barrel by the end of July.

The writer is Associate Director – Commodities & Currencies Business, Equity Research & Advisory – Angel Broking. Views are personal.

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