Brent: running ahead

Market participants have been preoccupied with the US rig count lately. Latest numbers from Baker Hughes shows the number of active rigs slipping down to 1,056; contracting rapidly from the October peak of 1,609. It is an important measure of the drilling activity, but not the only one. US shale oil producers will be moving to more productive and mature plays, reducing test drilling on the fringes and cutting costs. Still, along with renewed geopolitical concerns in the Middle East, it helped to push the market higher.

Importantly, supplies remain plentiful in the short term and are unlikely to cause any panic in the physical market. The spot premiums are relatively tame in the Atlantic basin while anecdotal evidence suggests floating storage has been back in high demand this winter (for the first time since 2009). The contango is more pronounced for the NYMEX benchmark while Brent’s premium over WTI soared in the past weeks. It is little surprise, given the weekly EIA estimates put US commercial crude inventories at fresh record highs (since the EIA has started reporting these).

Many were arguing last month, that by leaving the joint output target unchanged in November, OPEC had nearly achieved the ultimate goal of throwing high cost North American producers off the board. But, it would be premature to assume so since the late price rebound could well slowdown the scaling back in the US shale output.  In short, crude prices need to stay lower for longer. We need a sustained period of sub USD 50/bbl WTI prices for any significant dent in this year’s projected supply growth in the US.

As for Brent futures, the recent price rebound of around 40% from early January lows, has been far too rapid. The market in London might have bottomed out last month, also as shorts were forced to cover back above USD 50/bbl. However, it is hard to envisage a sustained rally from here also as winter in the Northern Hemisphere draws to an end while refining demand slows. In January, the EIA projected a mid-year rebound in prices, expecting Brent at USD 54/bbl in May and then at USD 70/bbl by year end. At above USD 60/bbl this week, the market is well ahead of expectations.

London’s global oil benchmark quite often trades on pure sentiment and supply fears. The market soared to near USD 115/bbl in the wake of the ISIS crisis last June only to then tumble nearly 60% by the end of 2014 as soaring supplies overwhelmed slugging demand growth. Renewed jitters over supplies from Libya had certainly helped to support London prices in the past week and add to the recent spike in volatility. Materially, there will be little impact from the pipeline fire into Hariga after the National Oil Corp. reported an output drop to around 0.18mbpd from 0.35mbpd in January. Still, caution is warranted also amid security threats in Iraq.

Provided there are no new geopolitical surprises, Brent prices should take a breather here, In our view, a limited price pullback is more likely than a sustained rebound in the near future.