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Crude market goes lower for longer

Supply is up and prices are low - the end of 2015 will not bring a revival of crude markets

If you thought the second half of 2015 would bring a revival in crude markets, think again. From weakness in China to resilience in US tight oil the news for sellers is bleak.

Start with supply, where the glut – an excess of 3.3m barrels a day (b/d) in Q2, according to the International Energy Agency - drags on, justifying front-month Brent’s 11% drop, to $57/b, since the start of July. Despite this, the big producer-countries’ output numbers remain robust. Defying the bulls, Russian production of 10.7m b/d was just shy of a record high. In Canada, firms are deferring investment in oil sands, but by 2017 – thanks to projects now being built – output will be almost 0.5m b/d higher than in 2014.

In the US, prices around $60/b in May and June ended the plunge in rig numbers and even brought some idled units back on line. Falling production costs, drillers’ focus on high-yielding wells and low interest rates have sustained output for much longer than expected. Despite the 60% drop in rig numbers in the first half of the year, US production still grew by 300,000 b/d and will average 9.5m b/d this year, 0.8m b/d above 2014, says the Energy Information Administration.

Saudi output of 10.35m b/d in June, its highest monthly figure, has loosened global balances too. Higher summer power generation partly explains this, but the increase is also strategic. The kingdom is in no mood to surrender customers to Iran and Iraq. Its determination to retain 2.5m-3m b/d of spare supply is fading, with long-term ramifications for the market. Petroleum Economist understands that Aramco has already recalibrated its system to handle sustained output of around 10.5m b/d, meaning the kingdom hasn’t even reached optimum production levels.

Higher Saudi output also lifts the baseline from which it would agree to cuts, which will eventually be a pressing matter. Within a year another 0.5-1m b/d of Iranian oil could hit the market, starting with the release of up to 45m barrels of stored oil. Iraq and Libya could both add similar volumes.

Global demand is another worry. China’s economic adjustment means it will need just 300,000 b/d more oil next year, or growth of about 3%, well beneath earlier trend rates.

Macroeconomic weakness in Europe and in commodity-producing countries also drags on world demand. The IEA says year-on-year consumption growth was 1.8m b/d in Q1 - but that was a peak, not a new norm. Next year’s expected rise of 1.2m b/d could be met by Iranian and Iraqi supplies alone.

Financial investors are now in retreat - a change in sentiment that will also weigh on prices. The ratio of long-to-short positions is now about 2:1 compared with about 15:1 in July 2014 (and 4:1 last month), according to US trade data extrapolated by Reuters.

Supply/demand fundamentals aren’t the only reason for bearishness. Markets expect a US interest-rate rise in the autumn. In case anyone needed another reason to short crude, a stronger US currency tends to lower the price of all commodities priced in dollars, including oil. 

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