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Is this the bottom?

The Doha deal and some changing sentiment are giving hope to a struggling market

After plunging to 12-year lows in mid-January, Brent prices have traded in a steady range of between around $30-35 a barrel, raising a simple question: has the market bottomed out?

A significant shift in Saudi Arabia's previous policy to keep the taps running at all costs gives some sign that it has. Cajoled by Venezuela, on 16 February the kingdom joined Russia and Qatar (involved because it holds the Opec presidency) in agreeing to freeze crude production at January's levels.

Front-month Brent futures responded by making temporary gains above $35/b before dropping back down to around $32/b later that day.  The four-nation Doha deal might have shown a new Saudi willingness to consider supply management - perhaps presaging genuine cuts later this year - but the agreement still depends on others joining in. On 17 February, one crucial producer, Iran, said it welcomed the pledge to freeze, but didn't commit to it. Iran wants to restore is pre-sanctions production capacity first.

What will boost crude prices are vast cuts to global capital expenditure on upstream production - something that, unlike the Doha deal, can be expected to mean actual cuts to production. Energy consultancy Wood Mackenzie says $380bn has been slashed across 68 large upstream projects. This equates to around 2.9m barrels a day of liquids production that will not reach the market until after 2020.

As bullish as the cuts look, they'll take a while to make a difference in the physical market. The IEA puts daily oversupply at 1.5m b/d - oil that continues to worsening the glut

Deep-water projects have been hit hardest, accounting for over half of the total, as companies are forced to rework their highest-cost and most capital-intensive developments.

Reform required

And where Opec isn't yet talking about real cuts, non-Opec producers are. Supply from these producers this year is expected to fall by around 0.6m b/d, believes the International Energy Agency (IEA). Even that might be too conservative. Bank of America Merrill Lynch expects non-Opec output will plunge from 57.7m b/d last year to 56.4m b/d. Petroleum Economist's survey sees 0.622m b/d lost from output throughout this year, if prices remain around their first-quarter 2016 level.

Bank of America expects output to rebound - but slowly, and not fully, either. Non-Opec production will only reach 57.5m b/d in 2020. If Brent prices remain in a $30-40/b range over the next five years, "no incremental conventional or unconventional projects will be sanctioned," it says.

That's a bullish force that should be hard to ignore. For the nearer term, either the bulls are at last stepping with a bit more confidence back into the market again, or bears are starting to get nervous. Hedge funds and other money managers had been amassing short positions - a bet that prices will fall - in Brent and WTI crude futures since the start of 2015. This helped drive some of the volatility that helped Brent touch 12-year lows on 20 January.

But the sentiment is changing. In mid-January, the short positions -- in Nymex and ICE Europe crude contracts - began to unwind, dropping from a record 392m barrels to 376m barrels over the week to 19 January.  Brent futures surged $4/b higher.

Data from the Intercontinental Exchange show short positions in Brent futures and options have fallen by almost 38,000 lots between 19 January and 9 February. Long positions, meanwhile, have increased by over 44,000. For the week ending 9 February long positions held 365,511 lots, up from 321,067 lots a month before. Short positions for the week ending 9 February were 100,179 lots, down from 136,015 lots for the week ending 5 January.

Brent futures

Quite when these lengthening positions will be rewarded, though, remains unclear. For all the straws being clutched by bulls, several factors suggest a recovery is still some way off.

As bullish as the capex cuts look, they'll take a while to make a difference in the physical market. The IEA puts the current daily oversupply at 1.5m b/d - oil that continues to flow straight into stocks, worsening the glut.

Unless the Doha deal leads to genuine cuts further down the line, meanwhile, its short-term impact is actually bearish. The output freeze at January's levels leaves production from Russia and Saudi Arabia at high baselines, effectively consolidating the oversupply. And if other producers don't abide by a deal they haven't signed up to, then Moscow and Riyadh might even see fit to go beyond their January levels.

The best description of the Doha deal probably came from the country that is likely to render it meaningless. Iran considered the deal "illogical".

The biggest obstacle for a recovery is simply brutal inventory mathematics.

IEA stock data show OECD commercial oil inventories built counter-seasonally by 7.6m barrels in December, reaching a huge 3.012bn barrels at the month's end. This is around 350m barrels above the fiver-year average for December.

Clearing that excess alone would need supplies to be beneath demand, by more than 1m b/d, for an entire year. Instead, despite non-Opec's decline, global supplies will continue to beat demand for months - even discounting the return of Iran's oil.

Keisuke Sadamori, the IEA's director of energy markets and security, says he doesn't expect OECD crude stocks to start falling until next year. "We will probably see continued stock building towards end of this year," he says. "Downward pressure (on prices) will continue for the foreseeable future."

Demand hardly offers reassurance either. It is expected to rise by 1.2m b/d this year, to 95.6m b/d. But that's 400,000 b/d less than it rose in 2015. Growing macroeconomic headwinds - on 18 February, the OECD downgraded its expectations for global economic growth this year - could yet erode that consumption forecast too. Some banks now expect growth of just 1m b/d.

So, painful as it feels, anyone hoping for a rebound will have to wait for those capex cuts to start killing off some supply. "As soon as supply starts to dissipate we can start to anticipate a (price) rebound, in about six months," says Hans van Cleef, an oil analyst at ABN Amro, a bank.

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