Oil prices have rallied more than 6 percent since last week, which has largely been attributed to growing confidence in a six-month extension from OPEC combined with a temporary outage in Libya and slightly better numbers from the EIA regarding refined product inventories. It still seems that the oil market is woefully oversupplied, but there are growing bits of evidence that when stitched together, start to resemble a market on the mend.
For example, the Financial Times reported that seaborne oil tanker traffic is down this year by 16 percent, a sign that the OPEC cuts are showing up at sea. Not all oil is traded at sea, obviously – some is shipped via pipeline or moved directly from the wellhead to refineries, processing facilities or storage. But such a drop off in the volume of oil moved at sea suggests that the supply cuts are being felt in the market.
It may seem curious then that oil investors are not picking up on this fact but Vortexa, an oil tracking firm, told the FT that the record high levels of inventories in the U.S. are probably disguising tightening conditions elsewhere. That is compounded by the fact that the U.S. provides the most thorough and timely data, while data tracking is much trickier elsewhere. That results in the U.S. having an outsized impact on the market narrative.
Vortexa says their data suggests that a fall in maritime trade this year is evidence of a tightening market. “Water is where the market changes first,” Fabio Kuhn, Vortexa CEO, said in an interview the FT. “We think this is some of the first evidence that supply cuts are having a major effect.”
Another small piece of evidence of a tightening global market can be found in the Caribbean, where oil inventories have already declined substantially. Bloomberg reports that crude inventories at Caribbean storage facilities have dropped by 10 to 20 million barrels over the past month and a half, a development that oil traders attribute to the OPEC cuts. Overlooked by the market until now, the drawdown suggests global supplies are moving closer to balance. "Caribbean and other storage has drawn down rapidly over the past weeks," Amrita Sen, chief oil analyst at Energy Aspects Ltd., wrote in a research note. "The first indications that the rebalancing has begun are here."
A growing number of investment banks and hedge funds are picking up on the tightening conditions in the market and coalescing around a more bullish picture than previously. For example, UBS wrote in a research note that oil prices could hit $60 per barrel within three months because of rising demand. Similarly, BNP Paribas said that inventory drawdowns will lead to a balancing of the supply overhang, resulting in Brent averaging $60 per barrel in 2017. Pierre Andurand of Andurand Capital Management went further, making a rather bullish call: oil will hit $70 this year. By late summer, Andurand says, oil futures will flip from contango into backwardation, ushering in sharper inventory drawdowns and higher prices.
This bullishness stands in contrast to some of the recent moves by major investors. Hedge funds and other money managers slashed their bullish bets yet again in the week ending on March 28. As Reuters points out, these investors have reduced their long positions by the equivalent of 170 million barrels over the last five weeks while increasing their short bets by 139 million barrels. The liquidation of bullish positions came after a remarkable buildup in net-long bets, so the unwinding of these positions was not a surprise.
While the selloff in bullish positions by major investors should drag down prices, it also puts the market on more stable footing going forward. The one-sided nature of the bullish positions this year through the end of February heightened the risk of a correction. Now, with investors taking a more balanced position on oil futures, there is less of a risk of another slide in prices. So, in a way, the selloff allows more room for oil prices to move back up.
The next steps for oil prices, as has been the case for some time, depend largely on what OPEC does over the next few weeks. The group meets again in a few weeks and could issue a recommendation on an extension of the supply cuts for the official May meeting. OPEC’s Secretary-General Mohammed Barkindo said this week that the deal is working. “I remain cautiously optimistic that the market is already rebalancing," Barkindo said on April 2. “We have started seeing stock levels coming down.”
Iraq bolstered the chances of an extension when it reported this week that it reached a 98 percent compliance rate with the OPEC deal. Because Iraq was one of the few OPEC members that had been dragging its feet regarding its pledged cuts, the higher level of compliance will improve trust when the members meet to discuss an extension. That is bullish for oil prices.
By Nick Cunningham of Oilprice.com
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