Oil recovery to continue in 2016?

By Gary Smith

Oil outlook for the second half of 2016

Since it bottomed out at $38 per-barrel in mid January, 2016 (so far, at least) has seen the price of Brent crude creep gradually upwards. The latest peak was seen on 7 June, when the price increased almost 1.1% to edge over the $51 for the first time since November.

So is this trend likely to continue? There was a simple reason for the oil price collapse in 2015: producers were pumping out the product at levels which significantly exceeded global demand. Looking at the price chart for Brent crude over the last six months, one might assume that this fundamental overproduction issue is on the way to being resolved.

In reality, there is little evidence to suggest that this is the case. Demand remains weak, while producers across the globe appear intent on keeping production levels as high as possible, in the hope that something turns up – or that their competitors blink first. There have, however, been a number of supply-side issues in the form of outages and interruptions over recent months (notably in Nigeria and Canada). The view among analysts is that once these short-term factors are taken out of the pricing equation, there is little in the fundamentals to suggest that the oil price won’t stall – or perhaps even start heading south again.

With this in mind, here’s an overview of the factors that are currently influencing oil and how future developments could sway the market.

Brexit and oil

“It’s mainly Brexit at the moment”. This was how ABN Amro energy analyst Hans van Cleef summed up the current attitude of traders when speaking to CNBC. Detailed consideration of the fundamental drivers of price (supply and demand) are currently on hold until the result of the referendum is clear.

If it is an out vote, expect traders to suddenly get very nervous about what this means for global oil demand. Christine Lagarde at the IMF and Janet Yellen at the Federal Reserve have been top among prominent voices warning that Brexit could have negative and significant implications across world markets – and this doesn’t just apply to currency markets and stocks. Brent crude  is currently hovering around the $47-$49. Very recent volatility within that bracket has tended to be linked to the respective fortunes of the Leave and Remain camps. Head of commodities research at Capital Economics, Julian Jessop indicated to Reuters that he expects a Leave vote to drive the price down to as low as $40.

Restraining production: Iran and its impact on global supply

Looking beyond Brexit, the oil price can only recover if oil-dependent economies are ready and willing to take steps to scale back production – at least until such time as global demand levels recover. Back in March, the consultancy company Oxford Economics warned that we need to see “significant changes to supply of the order of several million barrels per day”. There has been some movement on this in that OPEC and non-OPEC countries have at least been talking about a coordinated programme of output restraint. But the practical effects of these efforts have been lessened somewhat due to a further major producer coming online in the shape of Iran.

When a deal was reached for sanctions on the country to be lifted, the Iranians indicated that they intended to raise their supply by at least a million barrels a day – which would essentially represent a one percent increase in global production levels. Initially there was some scepticism over whether the Iranians would be able to meet these levels. In fact, the country has managed to ramp up production levels from just over 1 million bpd in the era of sanctions to a current level of just under 3 million bpd. What’s more, the Iranians have stated that they will not entertain the idea of a curb on production until its production levels top the 4 million bpd mark.

So what does this mean for trading decisions?

• Back in April, Brent crude leaked 0.36 percent in response to the news that Iran had rejected an agreement to cut back on production. Expect similar downward spikes on the back of statements from the Iranian government maintaining their stance. Conversely, if there is the slightest suggestion that the Iranians are willing to temper their position, this should trigger a short-term rise.
• Continue to check your industry news alerts for any meetings of top exports (both OPEC and non-OPEC). When the Saudis and Russians agreed to freeze output at January levels, traders gained confidence. If they look willing to go further, this is a solid bullish indicator.

“Local difficulties” in the form of supply interruptions

Rebel attacks on production facilities across the Niger Delta have seen Nigeria’s output slump by 800,000 bpd this year. The authorities are seeking to engage with people in affected areas to curb this, but so far with limited success.

When Canadian wildfires threatened production facilities back in May, Brent crude made temporary gains. But as soon as the wind changed direction away from key sites, those gains were also extinguished.  

Meanwhile, Libya looks set to unblock 300,000 bpd of production as some degree of stability returns to that particular area.

Local, often short-lived issues over production are almost impossible to foresee, but when they hit, the effect is seen almost immediately in the Brent crude price, in futures and in the stock price of companies exposed to the industry. The story of 2016 so far has been one of multiple supply-side disruptions in various parts of the globe overlapping each other, which has had the effect of alleviating the production glut.

So what should you look out for when placing trades? The absence of any further local disruptions, the absence of further meaningful agreement among producers on curbing output (and, of course, a Brexit vote) all call for a bearish position going forward. If events unfold in the other direction in each of these areas, then the opposite is true.   

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