The Seasonal Oil Selloff is Ending: Here’s Why…

June 26, 2017 12:49PM CDT

2Q’17 wasn’t supposed to go like this! Heading into the spring, the broad consensus in the oil market was that aggressive global inventory draws would move WTI into the mid $50s and beyond. Unfortunately, EIA data failed to deliver the bullish goods despite OPEC compliance near 100% due largely to output gains in the US, Canada, Libya, and Nigeria. So here we are, back trading near $43, and the physical re-balance plus flat price rally narrative that held so much promise has spiraled into some of the lowest levels we have seen in a while. 

Where can a market in disarray find support now that the aggressive inventory draw story has at least temporarily lost its momentum? The most potent bullish trend for the oil market would be a slowdown in U.S. production growth. The EIA sees U.S. production at 10m bpd in 2018, but the estimate is based on an average 2018 WTI price of $54/bbl. I think that sub $44 oil and steepening futures curve could slow the increase in U.S. rigs and generate headline-making credit stress for higher cost projects. Unfortunately, on a longer horizon, substantial flat price rallies will face a massive wall in the form of a fresh record high in U.S. drilled but uncompleted wells.

In geopolitics I would not count OPEC out in its ability to manage downside risk. The cartel’s 1Q’17 revenues increased y/y despite production cuts providing an important lesson in cooperation. On a longer time frame the cartel is obviously losing price influence to shale, but that doesn’t mean they can’t create headline risk in the near term by floating discussions of more aggressive cuts.

Lastly, I expect oil to find at least a small degree of support from short covering, technical buying (RSI and stochastics suggest oil is a conviction buy) and seasonally improved supply/demand data. Prompt WTI and Brent spread contango near 20 cents/month forecast strong inventory draws in the coming months, so perhaps the end is NOT near for oil.

 

Aug '17 Crude Light Daily Chart

Aug '17 Crude Light Daily Chart

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