The  crude  oil  market  is  fundamentally  playing  out  the  way  we  have expected. Crude oil price  volatility  will probably  remain throughout the year as each of the positive and negative events  become more evident. Our fundamental reasoning  for  the crude oil market  remains intact  –  ie it  will eventually find its equilibrium, but this will not happen overnight. Our  crude  oil  price  forecast  is  USD72.5/bbl  and  USD80/bbl  for 2015/2016, with downside risk to our forecasts.

If  oil  demand  and  supply  play  out  the  way  forecasted  by  theOrganization  of  the  Petroleum  Exporting  Countries  (OPEC)/
International Energy Agency  (IEA),  an  equilibrium could  be reached in 2H15.  The  last  time  we  had  a  balanced  market  was  in  1Q14,  andoversupply  started  from  around  2Q14.  Crude  oil  price  still  traded  at USD100-110/barrel (bbl)  in 1H14, but  started to slide since 2H14 as the oversupply  exacerbated.  We  could  see  the  crossover  point  again  in 3Q15,  where a  balanced  market is  expected.  It  will  be  interesting how crude oil price will react when this equilibrium is reached.  

The  negative  news  that  have  been  featured  in  the  media  and  will probably  continue  to  dominate  the  oil  market  news  flow  over  the  next couple of weeks are:  i)  higher crude oil inventories in the US,  ii)  the US supply  shows  little  signs  of  slowing  down,  iii)  Iran  may  reach  a  partial nuclear  deal  by  end-March,  iv)  the  strengthening  of  the  USD,  and v) lower demand from Japan.  Due to all those news above it is possible that the crude oil price could test new lows over the coming weeks.

The  positive  news  which  took  a  backseat  for  the  moment  include  asharp  drop  in  the  number  of  US drilling  rigs  to  866  rigs  currently,  the lowest  since  Mar  2011. Over the past 14 weeks, the US has sidelined 709  oil  rigs  as  the  price  collapse  prompted  energy  producers  to  cut spending  and  eliminate  jobs.  This  retrenchment  threatens  to  slow  the shale boom. The rigs left drilling in Texas Eagle Ford formation and the Williston Basin (part of the Bakken shale formation) are not enough to sustain  current  production  and  output  may  start  to  fall  over  the  next quarter or so. According to the  Energy Information Administration (EIA), the  US  oil  production  seems  to  be  reaching  an  inf lection  point  where output from shale  regions  could  begin to decline. Finally, we expect oil inventories to increase at a slower pace or even decline as we enter the peak demand season (the US driving season).

Crude Oil Price Market Update

Short-term crude oil price movements:

Crude  oil  price  rose  in  January  and  February  this  year  as  a  result  of  supply disruptions in Iraq, Libya and Iran which removed 885,000  barrels per day (bpd)from  the  global  oil  markets.  There  was  also  the  strong  winter  demand  in  the Western  Hemisphere  and  high  refinery  throughputs  (as  a  result  of  higher demand and higher refining margins).

Last week, crude oil price came under pressure again, with the Brent ending  the week  at  USD54.67/bbl  (-9%  WoW)  as  the  USD  rallied  to  a  12-year  high, increasing the cost of oil and other  USD-denominated commodities. There are also news of the US interest rate hike and warning from the IEA that the oil glut is growing.

It is highly possible that crude oil price will test new lows over the coming weeks as more negative news enters the market. However,  within the  negative news some  fundamental developments  are  playing out that  could,  over the course of time, evolve to cut supply.The negative news  for crude oil price  that has  been  featured in the media and will continue to  dominate the oil market  news  flow  over  the  next  couple  of  weeks  are: i) higher crude oil inventories in the US, ii) the US supply shows little signs of slowing down, iii) Iran may reach a partial nuclear deal by end -March, iv) the strengthening of the USD, and v) lower demand from Japan. The positive news that has taken a backseat for the moment  includes  a  sharp drop in  the  number  of  US  drilling  rigs  to  866  rigs  currently,  the  lowest  since  Mar  2011. Over  the  past  14  weeks,  the  US  has  sidelined  709  oil  rigs  as  the  price  collase prompted  energy  producers  to  cut  billions  in  spending  and  eliminate  thousands  of jobs.  This  retrenchment  threatens  to  slow  the  shale  boom.  The  rigs  left  drilling  in Texas  Eagle  Ford  formation  and  the  Williston  Basin  (part  of  the  Bakken  shale formation) are not enough to sustain current production, and output may start to fallover the next quarter or so. According to the EIA, the US oil production seems to be reaching  an  inflection  point  where  output  from  shale  regions  will  begin  to  decline. Finally, we expect oil inventories to increase at a slower pace or even decline as we enter the peak demand season (the US driving season).

Overall,  the  crude  oil  market  is  fundamentally  playing  out  the  way  we  have expected.  There will  probably  be crude oil price volatility  throughout the rest of this year  as  each  of  the  positive  and  negative  events  become  more  evident.  Our fundamental  reasoning  for  the  medium-term  and  longer-term  crude  oil  marketremains intact  –  the crude oil market will find its equilibrium, but this  will not  happen overnight.

Equilibrium should be reached by 2H15. If oil demand and supply play out the way OPEC/IEA  expected, an  equilibrium could be reached in 2H15. The last time we had a balanced market was in 1Q14, and oversupply started from around 2Q14. Crude oil price  still traded at USD100-110/barrel (bbl) in 1H14, but started to slide since 2H14 as  the  oversupply  exacerbated.  We  could  see  the  crossover  point  again  in  3Q15, where a balanced market is expected. It will be  interesting how crude oil price  will react when this equilibrium is reached (see Figure 1).

OPEC  Secretary-General  Abdalla  El-Badri  recently  said  that  the  global  oil  market will  return  to  balance  sometime  in  2H15,  as  demand  picks  up  and  high-cost producers trim output amid lower prices. He added that shale oil is not a challenge for OPEC, and the market should be left alone to determine prices that will decide which suppliers will survive. Over the next 25  years, the oil industry will need USD10trn to meet a forecast of a  60% increase in energy demand. Fossil fuel will remain central to the energy mix. According to a senior  Saudi  Aramco executive, the industry may cancel or delay about USD1trn of planned projects globally over the next couple of years. 

Source: RHB