Surplus fears return, WTI crude price may hit $52 level in Sept

Crude oil was on a roller-coaster ride in August with prices starting the month on a steady upward trend with WTI hitting $56 and later reaching lowest of $50 and then soaring back to $56 to end the month on a bunch of volatile factors, including “Trump Tweet” effect.

It seemed like global markets and crude are completely at the mercy of Trump’s tweets these days. One particular area of risk to watch is the further weakening of the yuan against the dollar. The yuan depreciated to 7.15 to the greenback, the weakest rate since prior to the global financial crisis 11 years ago.

The other headwinds were the ever increasing US production, which rose by 300,000 bpd to a record 12.5 million bpd. Prices received some boost after Iran's Foreign Minister Javad Zarif threw cold water on the prospects of any meeting with the US. This came a day after President Donald Trump floated the idea of easing restrictions on Iran.

The demand picture looks wobbly as worries over the supply side, where global production grew by a whopping 2.2 million barrels per day (mbpd), more than double its historical average. The vast majority of this growth was driven by US production. Since 2012 and the onset of the tight oil revolution, US production has increased by over 7 mbpd – broadly equivalent to Saudi Arabia’s crude oil exports – an astonishing increase, which has transformed both the structure of the US economy and global oil market dynamics.

Meanwhile, The Joint Ministerial Monitoring Committee (JMMC) of the Opec and non-Opec countries reported that July’s overall compliance level was 159 per cent and was 22 per cent higher than earlier. The report provides further evidence that Saudi Arabia was serious about stepping in to defend the oil price and their decisive action continues to support oil prices.
US energy companies have cut drilling rigs for a ninth month as rigs fell by 45, bringing the total to 742 -- the lowest level since January last year. Total US crude output fell in June for the second month in a row and market is forecasting rigs will continue to drop as oil prices remain in the mid-$50s range for WTI and around $60 for Brent. Rig operators are meeting their production goals as they adhere to capital discipline pledges and devise better well completion techniques, and now seek ways to further pare expenses.

Trump’s tariffs causing tension with allies
Trump’s power is expressed via social media. The US Federal Reserve’s power is exerted via the dollar, which has become more important globally in the decade since the financial crisis. China levied tariff of 5 per cent on US crude marks the first time the fuel had been targeted since the world’s two largest economies started their trade war more than a year ago and in retaliation, the US began imposing 15 per cent tariffs on a variety of Chinese goods on Sunday – including footwear, smart watches and flat-panel televisions.

China took 17 per cent of total US crude exports in 2018, just behind the biggest buyer, Canada which received 19 per cent of US shipments. The Chinese market share dropped to 7 per cent in the first half of 2019. This process kicked off days of fear among businesses and politicians on both sides of the border until Trump said that an immigration deal had been reached and scaled back his threats.

Demand and supply
Non-Opec i.e US production growth (YoY) is expected to reach 1.8 mbpd in 2019 and 1.9mbpd for 2020. These are very high non-Opec growth rates in an historical context, but significantly below the record high 2.8mbpd growth in 2018. The 1.8 mbpd supply growth from non-Opec this year stands in sharp contrast to the expected increase in demand of just 0.8 mbpd. Opec+ cuts have been required to keep the oil market from an utter meltdown, including deeper-than-required cuts from Saudi Arabia, and harsh US sanctions on Venezuela and Iran.

Natural gas
Natural gas prices had a volatile month as market participants start to look towards the colder months in and the amount of increase in demand for natural gas can be a major trigger for the next month.

The hurricane is providing some support, but there remains uncertainty as if hurricane hit Florida. It will have a bearish influence on natural gas prices because of lower cooling demand, while hurricanes in the Gulf of Mexico near Louisiana and Texas tend to have a bullish influence since that is where the natural gas production facilities are.

Prices are at critical point in year where volatility can increase due to seasonality shifts. With the summer cooling season winding down, traders will begin preparing for the winter heating season starting around September 1. Most of the price action is likely to be determined by what the massive amount of short-sellers decides to do with their positions.

Conclusion
As these battles progress from the “phoney war” to the real war stage and their impact on corporate sales and profits, as well as capital investment, begin to show, the correction in financial asset valuations is likely to be savage.

The market may see temporary drawdowns in inventories in the coming months due to extraordinary supply outages, but non-Opec supply growth and demand grinding to a halt means that the surplus is still set to return in 2020. It goes without saying that currency volatility and the risk of economic recession is bad news for oil prices. The Brent-WTI spread declined from $11.59 in late May to the $4.1 as on August 30. EIA expects WTI –Brent Spread will average $5.50 during Q4 2019 and in 2020, narrowing from $6.60 spread during July.

The narrowing spread reflects that crude oil pipeline transportation constraints from the Permian basin to refineries and export terminals on the US Gulf Coast will ease in the coming months. For the month, we expect WTI to trade with bearish bias, and touch levels of $52-53 for this month.

(Investors are advised to consult financial advisers before taking an investment calls based on these observations)