Analysts forecast ‘more of the same’ or drop for Q2 oil prices

Focus article by Cuckoo James

LONDON (ICIS)–US crude oil inventories are perched comfortably at historical highs with the industry at risk of running out of storage space and no signs of an OPEC output cut, leading analysts to conclude we will see ‘more of the same’ or even a crude oil price drop in the second quarter.

“Q2 will offer more of the same that we have seen so far in Q1. I see the price of Brent crude continuing to trade in a 50-65 dollar range with WTI crude roughly $10 lower than that,” said Ole Hansen, Saxo Bank’s head of Commodity Strategy.

Analyst predictions for crude oil prices in the second quarter seem to follow primarily from the ongoing increase in US oil inventories despite a steep fall in the number of uneconomical US oil rigs since last October.

As can be seen in the graph below, oilfield services company Baker Hughes data reveal the US rig count has fallen again in February.

The Baker Hughes North American Rotary Rig Count is a weekly census of the number of drilling rigs – a type of machinery – actively exploring for or developing oil or natural gas in the US and Canada.

To be counted as active a rig must be on location and be drilling or ‘turning to the right’, according to Baker Hughes.

Despite a drop in active rig count, US crude inventories rose to record highs for the ninth straight week in the week ending 6 March, data from the Energy Information Administration (EIA) reveal.

“Declines in the US rig count have yet to dent North American output growth,” the International Energy Agency (IEA) said in its March Oil Market Report.

Moreover, the US inventory of DUC – drilled but uncompleted – wells carrying plenty of oil in them are high.

“There are currently hundreds of DUC wells in the US shale oil regions and once the price rises these wells can quickly begin producing. So any major rise in prices during the first half is not expected.” Hansen said.

The combination of high inventories and the relative ease with which US producers can ramp up production should put a lid on prices.

But crude oil prices rallied in late January and early February, posting their first substantial gains since June 2014. ICE Brent rose $9.04 to an average of $58.80/bbl for the month of February, while the NYMEX WTI gained $3.40 to stand at $50.72/bbl.

In January, ICE Brent had ended at an average of $49.76/bbl, down $13.51 from the previous month. NYMEX WTI lost $11.96 to stand at $47.33/bbl for the month. Both contracts dropped below $50/bbl for the first time in over five-and-a-half years.

“The oil markets are currently in a phase of consolidation following the big sell-off,” Hansen said.

In technical analysis, consolidation is the movement of an asset’s price within a well-defined pattern. Consolidation is generally regarded as a period of indecision.

Producers’ cartel OPEC saw the February price rally as a defiance of fundamentals: “Since February, crude oil futures bounced back amid a mixture of factors, but largely supported by improving physical demand and supply outages, despite the fact that global supply continued to exceed demand.”

“The rally was also triggered by shortcovering spurred by speculation that the market had hit bottom amid geopolitical concerns in the MENA region,” OPEC said in its March Monthly Oil Market Report.

Paolo Scafetta from ICIS consulting said: “ICIS consulting view is for Brent prices to weaken between March and May, in contrast with the rebound recorded in February.”

He cites a number of reasons for the decline, including the seasonal planned refinery maintenance in spring which would mean less demand for crude oil to make gasoline, naphtha, mid-distillates and other refined products.

He added: “Growth in oil demand is expected to remain relatively weak, contributing to a persistent oversupply of crude over the next few months.”

“In terms of oil production, despite the steady drops in US rig counts [over 34% from early December 2014 to the end of February] we expect an overall increase in US crude short term output,” Scafetta said.

Hansen said: “The existing imbalance between supply and demand can only be reduced through the reduction in output from either OPEC or non-OPEC producers or through a pick-up in demand.”

The IEA noted the apparent price stability in early March was based on “a precarious balance”: “Behind the facade of stability, the rebalancing triggered by the price collapse has yet to run its course.”

Storage space is a major issue. US storage tanks could fill before production begins to decline. Any substantial decrease in oil production could potentially happen in the second half of this year.

Goldman Sachs President Gary Cohn said in an early March interview that WTI could fall to $30/bbl as the US oil industry runs out of storage space, especially in the mid-continent and Texas.
 
“The unwinding of seasonal refinery maintenance may slow US crude stock builds in 2Q15 but will not stop them, and stocks may soon test storage capacity limits,” the IEA said.

“That would inevitably lead to renewed price weakness, which in turn could trigger the supply cuts that have so far remained elusive. While the US supply response to lower prices might take longer to kick in than expected, it might also prove more abrupt,” the IEA added.

Hansen is a bit more cautious on the impact of any production cuts on second-quarter prices: “We should see production from non-conventional sources begin to slow but whether it will have a major positive impact on prices this quarter remains to be seen.”

As a possible nuclear deal with Iran advances, there are concerns this could lead to fresh supply in the market.

With so much focus on supply, it is tempting to ignore global oil demand forecasts for the second quarter.

“On the demand side we are seeing signs of a pickup but we do not see a major price impact of this during Q2,” Hansen said.

Scafetta said: “A gradual increase in crude oil prices is then expected by the third quarter, as demand recovers and oil production starts to decline.”

The IEA said: “Demand may have been supported by opportunistic buying and growing interest in storage plays [but] there are still few firm signs at this stage that lower prices are giving the economy a boost. China, for one, remains in a cooling mode.”