Resistance to crude upside looks firm despite supply shocks

May 2, 2019

Green sprouts appearing through dark soil has become the narrative in FX markets this quarter as global headwinds begin to ease. However, after the strong correction in Q1, the same cannot be said for oil markets as the rally begins to peter out.

Despite much speculation over the current demand and supply conditions, we maintain our base case of WTI trading within the $60-65 range in H1 2019.

– Simon Harvey, FX Market Analyst at Monex Europe.

The muted reaction in crude markets after the US refused to extend a 6-month waiver on Iranian sanctions for oil importing countries evidenced how resistant the upside is for oil.

Even with the tightening of sanctions and demand conditions picking up as global growth stabilises, crude prices are unlikely to strengthen significantly due to amount of spare capacity under the latest OPEC+ quotas.

Under the current regime, Saudi Arabia can commit to a further 500,000 bpd and still meet their pre-existing commitment, while other oil exporting countries such as Kazakhstan and the UAE also have room to increase output.

Further, high inventory levels in China and the inability of the manufacturing powerhouse to quickly find alternative oil supplies suggests that the sanctions will be accepted. This limits the impact the current supply restrictions have on crude prices, a theme that will most probably carry over into OPEC’s meeting in June.

WTI prices prove resistant to further upside after recently hitting a 2019 high of $66.60:

 

 

Has WTI oil therefore reached a top?

In short-term the answer is yes, given no unexpected market shocks.

Spare capacity under the current regime remains plentiful and despite demand conditions improving, the gradual pace of the growth pickup does not point towards a substantial increase in output just yet. In addition to this, cracks in the current agreement are beginning to show with Russia hinting at opening the taps once again.

The June meeting will be pivotal for the second half of the year, where we expect the current regime to be extended but only by a few months ceteris paribus.

In the coming quarters, however, investors will look at global inventories, production levels in countries such as Saudi Arabia who are below their quota limit, and an increase in US rig counts.

There are risks to this stance, however. The loss of Libyan exports due to domestic instability are yet to be realised in crude markets just yet.

The flare up in domestic politics could wipe out 1.1m barrels per day in production, and poses a substantial risk to breaking the current quota agreement should Libyan exports grind to a halt like they did in 2014.

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