Commodities | Apr 04 2018
Oil prices may have slipped recently but analysts expect prices will be underpinned over the rest of 2018.
-Uncertainty surrounding US-China trade policies likely cause of recent oil sell-off
-However, positive momentum continues and market expected to remain reasonably balanced
-US infrastructure constraints, risk of a return to Iran sanctions and Venezuelan cuts supportive
By Eva Brocklehurst
The trigger for a sell-off in oil prices earlier this week appears to be uncertainty surrounding the impact of US policies on markets, amid concerns about growth in global trade.
China instigated a harsh response to US tariffs on steel and aluminium – some tariffs are as high as 25% on US products – which, in turn, resulted in large US companies criticising President Trump's approach and raising fears the long period of sustained growth could be coming to an end.
Citi notes, even though the US-China oil trade balance is improving rapidly, other factors are widening the broader trade deficit. Disruptions to US-China crude, refined product or LNG trade as a form of Chinese retaliation may hurt the US President's attempt to close the US trade deficit.
The impact on the overall US trade deficit is not that clear, as oil and LNG cargoes would likely find a place elsewhere. In 2017 US oil net exports to China averaged around 435,000 b/d, a 140% increase year-on-year from 2016.
Citi suggests the Trump administration will need to push back forcefully on any Chinese move to impose tariffs on energy trade if they want to reduce the deficit. If left unrestricted, US net oil flows to China are likely to increase sharply, as US crude is pricing competitively in Asia and the US does not have spare refining capacity to absorb domestic supply increases.
Despite the recent uncertainty, a decline in oil stockpiles in the US and other advanced economies has been the primary driver of stronger oil prices over the last 8-12 months. Not only are US stockpiles below the five-year average of 2013-2018 for this time of year but even OECD stockpiles are close to the five-year average.
Commonwealth Bank analysts now expect any surplus building in oil markets will be muted this year, while deficit risks are emerging, particularly with a large decline Venezuelan production and the US facing infrastructure constraints.
Previously the analysts believed the end of the OPEC agreement would mean supply came back on line quickly to flood the physical market, weighing on prices. However, the balance of risks suggests OPEC can maintain discipline and now the market is expected to be kept in balance.
Earlier this year Deutsche Bank was concerned US exports would shrink and lead to a weakening of the regional supply-demand picture. Instead, there is been some stability in US exports and a slight widening of the spot spread.
Longer term, Deutsche Bank expects supply to grow faster than US domestic demand and force exports to rise. The broker still envisages positive momentum in the market and finds no reason not to be generally constructive.
Iran
A heightened risk of sanctions being re-applied to Iran is also likely to keep oil prices well bid. The only concern Deutsche Bank has, between now and the end of the year, is for some of the geopolitical risk premium to disappear if a supplemental deal is agreed that addresses President Trump's concerns.
The broker notes recent US government staff appointments could spell trouble for the Iran nuclear containment deal. Withdrawal by the US now appears more likely, given incoming US Secretary of State Mike Pompeo and national security adviser John Bolton have both expressed hawkish views regarding sanctions relief.
Venezuela
Commonwealth Bank analysts suggest over-compliance with production cuts by OPEC members, particularly Venezuela, have helped the oil price rally. While US oil supplies are expected to rise sharply, infrastructure constraints there may pose a problem by August. Prices could break through recent highs, which would mark the highest prices since late 2014.
This outlook is predominantly being driven by the OPEC-led deal to sideline around 1.8% of global supply. Key is Venezuela's collapsing oil production, regarded as the largest unplanned outage in history, that reflects an ongoing economic and debt crisis, US sanctions and lack of funds for investment or maintenance.
Commonwealth Bank analysts are now more positive about the outlook for oil prices and expect Brent crude to average US$65/bbl in 2018 and US$61/bbl in 2019.
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