Crude rallies past $65/barrel, but disconnected from fundamentals

A relentless drop in the number of oil rigs operating in the United States, juxtaposed with a slight decline in production, prompted bulls to call an impending end to the shale momentum, a sentiment that found support from a drawdown in stocks at Cushing, Oklahoma, a major oil-trading hub, through the second half of April, breaking a spell of continuous builds going back to December 5.
A weakening US dollar was also a key driver in the rally. The dollar index skidded nearly 5 per cent from a high of 99.49 on April 13 to a low of 94.60 April 30.
Meanwhile, an escalation of conflict in Yemen injected some fear premium into oil prices, mainly due to concerns over shipping through the neighbouring Bab al-Mandab strait, though there was no actual impact. Just under 4 million barrels a day of oil passed through the waterway in 2013.
April witnessed a surge in speculative length in crude futures contracts on both sides of the Atlantic. Money managers had built the largest net long positions on NYMEX crude futures the week ended April 21 since end-July 2014, while speculative net longs on ICE Brent futures rose to new all-time highs through the month.
That helped Brent futures notch up nearly 17 per cent gains through April, while NYMEX crude ended 19 per cent higher.
However, quite a few viewed the rally with scepticism and said it was unsustainable, given bearish fundamentals: an oversupplied market, plentiful stocks, and anaemic global demand growth that has failed to catch up with production.
As of April 24, the number of oil rigs operating in the US was only 44 per cent of last October’s peak, but production was still over a million barrels per day higher than the same period of 2014.
The bulls were likely taking their cues from weekly US Energy Information Administration (EIA) data showing output had slipped by about 56,000 barrels per day as of mid-April from the peak of 9.42 million barrels per day recorded in March. The EIA also flagged expectations of the first net drop in shale-oil output of 57,000bpd in May.
But the bigger picture painted by market watchers is of the shale industry proving to be resilient, thanks to supply-chain cost deflation and increasing drilling efficiencies. Some US shale producers have cut costs by up to 80 per cent, according to Wood Mackenzie, joining a select group with cash-flow break-evens below $60 a barrel.
More important, any uptick in NYMEX crude toward $65 levels is expected to spur US shale producers to crank up output, promising a long road to any sustained recovery in prices.
The Organisation of the Petroleum Exporting Countries (Opec) added to the plentiful supplies, helped by strong Saudi and Iraqi volumes. Not only was its March production pegged at 30.72 million barrels per day by Platts, above its 30mbpd target, but also 1.4mbpd in excess of the group’s own estimated average demand for its oil this year, with April figures seen coming in even higher.
Russian production and exports continued to grow despite sanctions against the country, with April output up 1.6 per cent year on year to around 10.71mbpd.
Iran, which is preparing to boost its production and exports once it has a comprehensive agreement with six world powers over its nuclear programme in place, could potentially flood the market with up to 1mbpd additional oil, though the pace of the flows, which would be dictated by the easing of the sanctions, is uncertain for now.
Iran currently exports around 1mbpd of crude, less than half the 2.2-2.3mbpd it exported before the imposition of the latest round of oil and financial sanctions by the European Union and the US in 2012.
Oil minister Bijan Zanganeh said Iran would raise production to 3.8mbpd within six months of the sanctions being removed – Platts pegged its output at 2.5mbpd in March – and called upon Opec to make room by slashing its output target by 5 per cent.
However, the consensus view is for Opec staying the course when it meets in Vienna on June 5. The producers’ organisation has again slammed the behaviour of independent oil-producing countries in recent weeks and reiterated that the burden of curbing oversupply needs to be shared by all producers.
On the other side of the equation, oil-demand growth remains unconvincing, though the latest forecasts by the International Energy Agency, Opec, and the US EIA on average call for a relatively strong 1.1mbpd rise in world consumption this year.
US petrol demand, which accounts for nearly a tenth of global oil consumption, has become a focal point, having received a boost from low prices ahead of the key summer driving demand season. The EIA expects petrol consumption to rise by 150,000bpd this year, compared with an 80,000bpd increase seen in 2014.
Weekly EIA data for the first four months of this year show US petrol demand just over 3 per cent or 250,000bpd higher from the corresponding period of 2014.
China, the engine of global oil demand growth for the past decade, is slowing down as well as reducing its energy intensity. First-quarter economic data showed the weakest economic expansion since 2009 at 7 per cent, and manufacturing activity remains sluggish.
Though the country registered a 4-per-cent rise in apparent oil demand to an average 10.48mbpd in the first quarter of this year according to Platts calculations – the fastest pace of growth since 2012 – it might well prove to be the peak for the year.

Vandana Hari is the Asia editorial director at Platts, a global energy, petrochemicals, metals and agriculture information provider and a division of McGraw Hill Financial. She can be contacted at [email protected].