HomeResearch and NewsOil Market Report - March 2018
Vitaly Gromadin CFA, Senior Analyst
Report

Oil Market Report - March 2018

EXECUTIVE SUMMARY

In March crude oil market had been mostly in consolidation phase before breaking through technical resistance level and recovering to local maximum.

Geopolitical risks were believed to support the returning of bullish sentiment. The risks of trading war between China and the USA were also taken as a positive sign for crude oil market somehow due to possible limitation of shale oil growth in the USA because of service costs inflation and investors preference to see positive free cash flow.      

The rise of geopolitical risks was mainly explained by hawkish characteristics of men appointed on key government posts by the U.S. President recently. Additionally, Mr. Trump and Crown Prince of Saudi Arabia have met in Washington to discuss Iran threat among other things. The USA could quit the Iran nuclear deal in May if Trump finally chose to do so.

Geopolitical premium tends to ease without further escalation. If storage levels data turns negative for the price it will be hard to go above prior maximum.

DOE weekly petroleum data has also been supportive for prices so far. Refinery utilization level is again at the record level for this time of year, which can be interpreted as a sign of strong demand. Meanwhile storage levels of crude oil and products are mostly lowering. However, oil production numbers are very negative for the price and the market has seemingly ignored that factor (even with record shale oil production volumes the stocks are lowering).   

Wall Street is apparently prioritizing free cash flow above drilling new wells in the sector no matter how high crude oil prices are. Oil producers with announcing share buy-backs have actually shown some outperformance relative to growth-oriented peers. Possibly investors tried to avoid destiny of natural gas industry where production growth has been continuously hurting natural gas prices in the USA which negatively effects shares of Gassy producers (especially indebted ones). 

Crude oil Bulls could be arguing that U.S. shale producers will limit its activity to avoid another crash in oil prices and lure back investors from Wall Street (the sector is very undervalued now). It is a good point but several key things:

1.       U.S. oil industry are highly competitive with enormous number of private companies;

2.       Majors like Chevron and Exxon having free cash flow, dividends and buybacks already are becoming more active in shale oil production;

3.       Bond market has not seemingly punished for overspending yet and it is open for producers given high crude oil prices.

U.S. oil production records according to EIA weekly estimates cannot be totally ignored though as lagging monthly data supports these high numbers. The monthly oil production data is much more reliable and production volumes were almost at 10 mln bbl / d in January. The difference between high end and low end of the range 1.5 mln bbl / d - 1.1 mln bbl / d in 2018 for U.S. oil shale growth is only important in the case of strong and steady demand. However, there are always downside risks for demand because of several years of above average demand growth in a row already. That is why crude oil price looks very sensitive to SP500 index dynamics.

There is a strong probability for a significant correction given record net long positioning in oil futures. Fund managers’ long positions (in Brent, NYMEX and ICE West Texas Intermediate crude, U.S. gasoline, U.S. heating oil and European gasoil) outnumber their short ones by a record ratio of 12.5:1, according to an analysis of records published by regulators and exchanges. Ratio of money managers’ long to short positions in New York gasoline futures and options is at almost 26, having surged from 10 in the recent weeks.

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