Oil market looks neutral to bearish in near term as focus returns to fundamentals

The UK’s Brexit vote dominated oil market sentiment for most of June, not because of its direct impact on oil demand and supply but through its impact on the US dollar index and financial markets.

The UK economy plays a very small role in the global oil market, with the UK accounting for about 1 per cent of global oil supply and 1.6 per cent of demand.

A stronger dollar, however, makes oil imports more expensive for holders of other currencies and is generally seen as bearish for demand. The US Dollar Index hit a three-month high of 96.7 in the aftermath of the UK’s decision to leave the EU.

A rally in crude futures that began in February stalled this month under the weight of a rising dollar, pushing prompt contracts for NYMEX crude and ICE Brent back below US$50/b.

Brexit also raised the degree of volatility in the futures market. Realised volatility for front-month crude ticked higher in the run up to the Brexit vote, arresting a steady slide that began in February, when volatility hit highs not seen since early 2009.

Front-month NYMEX crude volatility hovered around 30 per cent, up from less than 20 per cent earlier this month, according to data supplier GlobalView. That figure was above 90 per cent in February.

But the market has now digested the Brexit vote and focus is returning to supply-demand fundamentals.

With Nigerian and Canadian oil production gradually returning and gasoline stocks at levels sufficient to meet summer demand, the market is looking more neutral to bearish in the near term.

Oil production in Nigeria rose to 1.9 million b/d in late June, up 300,000 b/d from a month ago as a 30-day ceasefire agreement reached last month between the Nigerian government and militants targeting the country’s oil infrastructure has provided hope for a longer truce.

The ceasefire is expected to provide President Muhammadu Buhari with the opportunity to reach a comprehensive plan to solve the problem of militancy in the Niger Delta.

Nigeria’s crude output slid to 1.42 million b/d in May, the lowest level since January 1989, from 2.2 million b/d, according to S&P Global Platts Opec survey data.

In Canada, some 880,000 b/d of the 1.51 million b/d of shut-in production due to the wildfire in early May was brought back online by mid-June, implying that the level of shut-ins currently stands at around 629,000 b/d.

On the supply side, what market observers are keenly watching for now is to see if US crude production ticks higher with crude prices having roughly doubled since February to around US$50/b.

Latest data from the US Energy Information Administration showed that US crude oil production slipped by 55,000 b/d to 8.622 million b/d in the week ended June 24 from 8.677 million b/d in the previous week. Production has come off 123,000 b/d since early June.

According to Keisuke Sadamori, director of energy markets and security at the International Energy Agency, the rebound in crude futures to around US$50/b led to an increase in rig counts but has not been sufficient to halt overall decline in US shale oil production.

In the mid- to long term, US shale production would need oil to be at more than US$60/b to trigger an increase in production and sustain it, Sadamori told Platts recently.

On the demand side, the market is paying close attention to US gasoline data as the summer driving season gets underway.

But this demand is being met with robust US gasoline production and high stocks. As US gasoline stocks have broken above the five-year average and global gasoline inventories have swelled, gasoline crack spreads have come under pressure, potentially capping significant upside in crude futures.

But overall global oil demand looks strong. The IEA in its June monthly report maintained a return to balance in world oil markets for the second half of the year, increasing its estimate of annual demand growth to 1.3 million b/d this year and next.

The agency increased its estimate of global growth this year, citing a stronger stimulus as a result of low oil prices than previously realised. Abandoning a projection of 1.2 million b/d growth that it had stuck to for seven months, it said statistical revisions showed demand in the first quarter had grown by 1.6 million b/d on the year, led by Asia.

So while on the supply side, the outages of the last few months appear to be easing out, on the demand side, it remains to be seen if Brexit will have wider implications on the global economy and global oil demand growth and exert downward pressure on oil prices.

Jaipuriyar is associate editorial director, Asia and Middle East oil news and analysis, at S&P Global Platts