Market analysis by Tim Fox: Inventory and US rates to hit oil price

Oil markets received a reality check last week, with West Texas Intermediate (WTI) and Brent falling by more than 9 per cent and 8 per cent, respectively.

The culprit was a bearish confluence of US dollar-supporting jobs data, a more than 8 million barrel build-up in US crude stockpiles, taking them to 528.4 million barrels, and a speculative market that was overextended. Total inventories have now hit new record highs four weeks running and stockpiles have increased by about 50 million barrels since the start of the year, and this despite Opec production cuts that have gone deeper than anticipated.

The fall in oil prices came as oil ministers and industry executives from Opec and non-Opec countries were gathered at CeraWeek in Houston, causing Opec leaders to confront the possibility of having to extend their November agreement beyond its June expiry.

Saudi Arabia has already cut production more deeply than it pledged in November and Suhail Al Mazrouei, the UAE’s energy minister, said the country had achieved 105 per cent compliance. The minister expects between 170,000 barrels per day (bpd) and 200,000 bpd of further output cuts over the coming months, but there appears to be frustration that non-Opec countries such as Russia have been slow to keep their side of the agreement, while there is little that can be done about US shale production, which has recovered much faster than anticipated.

US output has surged to its highest level in more than a year, reaching 9.09 million bpd in the week ending March 3, the most since February 2016. The US rig count has also been rising for the past nine months.

Speculators have also played their part in the rollover in price. Although speculative investment in oil futures cooled somewhat in the previous week, with new short positions coming into Brent and WTI futures, the benchmarks were still heavily weighted towards long positions by the middle of last week.

Brent closed at US$51.37 per barrel on Friday, its lowest level since early December, while WTI is back below $50 per barrel for the first time since November, closing the week at $48.49. Both markers closed below their 100-day moving averages and punched through some longer-term technical support levels, which may be opening the way up for more downside ahead.

Clearly the scope is still there for further capitulation of speculative positions, something that may not abate until the much anticipated increase in US interest rates is out of the way later this week.

Oil’s rout is occurring amid mounting speculation that the Federal Reserve is going to pull the trigger on its third rate hike of the current tightening cycle, earlier than most expected, giving a further spur to dollar bulls. Janet Yellen telegraphed a move just over a week ago, and strong lab­our market data at the end of last week has pretty much cemented the markets’ certainty that a hike is coming on Wednesday, when the Federal Open Market Committee meets.

What is less certain is what the Fed’s messaging will be about further rate hikes, which will probably determine whether the dollar can sustain its recent gains. Since the start of the year markets have been pricing in the likelihood of two rate hikes in 2017, in contrast to the Fed’s December “dot plot”, which implied three.

Given the strength of the February jobs data, it would not be a surprise if the third hike becomes priced in, with even the possibility that the markets begin to look for a fourth this year. The dollar would be sure to recapture its bid tone under such circumstances, which would act as a further headwind to any oil price recovery. Opec ministers were understandably tight- lipped last week about what they will do when their November agreement expires in June, but a scenario of dollar strength and renewed oil price softness will almost certainly keep the speculation of a deal extension alive all the way to their next meeting in May.

Tim Fox is the chief economist and head of research at Emirates NBD.

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