French Highlights Oil and Gas

Why 2019 Could Start With An Oil Rally

Oil prices have regained significant ground since the Christmas Eve meltdown, and there is potential for higher prices in the weeks ahead.

Trying to guess what will happen next with oil is foolish, but several trends and upcoming events could pave the way for a tightening up of the oil market.

As we close out the year, December could potentially go down as the low point in the latest price cycle.

To start with, the OPEC+ cuts take effect at the start of January, and in reality, even if the group does not reach the promised 1.2 million barrels per day (mb/d) right away this week (it surely won’t), the reductions have been likely underway for some weeks.

By some counts, OPEC production fell more than 800,000 bpd in December, most of which came from Saudi Arabia.

So, we start the New Year with big reductions in supply.

The cuts will not balance the market right away, and there is disagreement from analysts over whether or not the size of the reductions is ultimately sufficient.

At a minimum, the group may need to extend the cuts through the end of 2019 instead of letting them expire in June. But top OPEC officials have already signaled that they are willing to do that.

The second reason that the oil market may have bottomed out is that the waivers on Iran sanctions are set to expire in May.

The latest data from Reuters shows that the volume of imports by Asian countries of Iranian crude hit a low in December at 664,800 bpd, down 12.7 percent from a year earlier.

However, countries such as South Korea and Japan have indicated that, with waivers from the U.S. Treasury in hand, they could buy more oil from Iran beginning in January.

Thus, Iran may not necessarily play a bullish role in the oil market right off of the bat, but the waivers are set to expire in May.

The Trump administration will probably be far less lenient this time around, and it will have a looser oil market giving it a stronger hand compared to late October/early November.

Estimates vary, but Iran is expected to lose a significant portion of its oil exports, which, combined with the OPEC+ cuts, could go a long way in erasing the surplus.

Third, U.S. shale could finally undershoot growth expectations. This factor is admittedly speculative, but the crash in oil prices likely pushed a lot of shale drillers back into unprofitable territory.

While many companies boast of low breakeven prices, around a quarter of them aren’t profitable unless oil trades above $65 per barrel.

At a minimum, plans for new rigs and new drilling could be scrapped. And indeed, there are early signs that is already happening. But if WTI lingers in the $40s for a while longer, there will surely be more severe revisions to 2019 drilling plans.

The EIA says the U.S. will add 1.2 mb/d of fresh supply in 2019.

To the extent that the shale industry fails to deliver on this expectation, it will act to tighten up the market.

Another reason why the oil market could rebound from current levels is that there are few areas of significant supply growth outside of the U.S., and hardly any that could surprise on the upside.

Canada and Brazil could add barrels onto the market, but not even close to anything that is expected from the U.S.

In fact, if there are supply surprises, the unexpected event is much more likely to be an outage. Nigeria has an election in 2019, which could spark unrest and put supply at risk.

Production from Libya, as always, is fragile. Libya’s production rebound in 2018 was impressive, but the gains are easily reversible. Venezuela’s decline is much more certain.

The discussion up to this point has been all about supply. But, arguably, the oil market narrative in 2019 could be dominated much more by demand.

Signs of strain on the global economy are piling up by the day. Stock markets have been rocked by volatility, the Fed’s rate tightening has rattled confidence and increased the cost of debt around the world while also shaking emerging market currencies, and an economic slowdown appears underway in China.

Just this week, data shows that China’s manufacturing purchasing managers index dropped to 49.4 in December, the weakest since early 2016.

“What is clear is that the global synchronized growth story that propelled risk assets higher has come to the end of its current run,” Singapore-based Oversea-Chinese Banking Corp. said in an economic outlook, as reported by Bloomberg. In China, “a further growth deceleration remains on the cards.”

Forecasts from the EIA, IEA and other major energy watchers have demand growth at relatively strong levels, albeit slightly weaker than 2018.

Any faltering in the global economy could more than outweigh the array of supply-side factors that could tighten up the market. Time will tell.

Most major investment banks on Wall Street see oil prices rebounding relatively strongly in 2019. Despite sharp downward revisions, bank analysts see Brent averaging in the $60s-$70s, which could require a rather significant rally given today’s prices.

source: oilprice

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