Oil is on course for a second annual gain after last month’s decision by OPEC, Russia and other non-OPEC members to extend production curbs in an effort to rebalance the Oil market.
As of writing, Brent is hovering near $64.00 levels; up 12 percent on a year-to-date (YTD) basis. Meanwhile, WTI is trading at $57.80 levels; up 6.96 percent on a YTD basis.
While technicals point to solid gains in 2018, the fundamentals sound less bullish.
Technicals - Bullish outlook, could test $80.00
That said, in the short-run, a minor pullback cannot be ruled out says the daily chart.
WTI daily chart
The above chart shows:
- Potential head and shoulders reversal with the neckline at $56.20. A close below the neckline support would open doors for a pullback to $53.50 levels (target as per the measured height method).
- However, the 50-day MA, 100-day MA are curled up in favor of the bulls. Further, the weekly 5-MA and 10-Ma are sloping upwards as well.
- The weekly chart also shows prices left a higher low (in June at $42.08) and moved above the cluster of resistance at $55.00 in a convincing manner. Clearly, the bulls are in control here.
- Hence, dip to $55 or below (due to head and shoulders breakdown) is likely to be short-lived.
Fundamentals - Focus on Shale-OPEC showdown
US Shale output: could derail OPEC's efforts to rebalance the oil market. The International Energy Agency (IEA) believes the rising US shale oil output is likely to delay the too late 2018, said. It sees an oil surplus of 200,000 barrels a day in the first half of 2018 before the markets see a deficit of 200,000 b/d in the latter half of the year. This would leave 2018 as a whole “showing a closely balanced market”.
- Hedging activity indicates shale explorers are gearing up for a surge in output in 2018: The US Commodity Futures Trading Commission reported on December 8 that the net-short position of swap dealers (an indication of hedging) increased for an eighth week to a fresh record. As per Reuters report, it indicates the producers are finding the upper-$50-a-barrel environment a key time to lock in prices.
- US drillers' spending plans: US oil and gas Capex increased more than 20 percent year-on-year in the first three quarters of 2017 and is set to rise at a faster rate next year. Rigzone reported on Nov. 2 that oil majors are set to increase exploration Capex in 2018. John Jeffers, Group Development Director for Oil & Gas at SNC-Lavalin, said, "leading oil majors are expected to increase their exploration capital expenditure (CAPEX) by 20 to 30 percent next year. For instance, Chevron Corp has informed markets that its spending on shale will rise 70% from this year. The breakeven for the Wolfcamp, Bakken and Eagle Ford basins is below $40. With oil above $60, there is a tremendous incentive for shale producers to drill more in 2018.
Clearly, the shale output is set to rise at a faster rate next year. This might explain the signs of bull market exhaustion in oil prices post-OPEC decision to extend the output accord until end 2018.
Focus on OPEC compliance and exit strategy: Oil above $60 could entice OPEC members and Russia to produce more than what they have pledged under the output cut accord. Noncompliance would derail oil market rebalancing and could lead to oil price sell-off.
Also, OPEC's exit strategy (how it will unwind its supply agreement) will influence prices. The output accord is a sort of stimulus (as rising oil prices keep energy shares well bid) and also creates room for advanced nation central banks to unwind their stimulus program. So, the cartel needs to engineer the exit strategy in a way that would only result in a moderate weakness in oil prices.
A sudden return to full production capacity could yield an oil price crash. Hence, OPEC is more likely to opt for a gradual liftoff (similar to the Fed's gradual policy tightening!). The exit strategy is likely to be discussed in detail at the June 2018 OPEC meeting.
Supply Disruptions: There is always a possibility of oil price spike due to the escalation of the crisis in middle east/Korean peninsula etc. The natural calamities could also create supply disruptions and have serious implications for the oil market.
Oil bullish scenario - A slower than expected rise in the US shale output, coupled with high OPEC compliance could push prices higher to $70.00 ahead of the June OPEC meeting. Further gains to a technical target of $80.00 (Brent) in the second half of 2018 looks likely if OPEC is successful in convincing investors it won't flood the market once the curbs finally expire.
Oil bearish scenario - Evidence that OPEC members and Russia are violating production ceilings could single-handedly derail the oil rally and push prices back below $50.00 levels in the first half of 2018. Add to that rising shale output and prices could breach the long-term rising trend line (drawn from Feb. 2016 low and June 2017 low) and extend the decline to $40.00 levels.
The most likely scenario:
- OPEC compliance rate remains high.
- The Cartel beings telegraphing the gradual exit (withdrawal of production caps) in the second half of 2018.
- Non-OPEC supply, especially shale output rises at a faster rate as indicated by the Capex projections of shale producers and their hedging activity.
So oil prices could have a tough time moving above $66.00 (WTI) and $70.00 (Brent). However, technicals indicate scope for a rally in Brent to $80.00 levels. Such a move looks likely if the geopolitical tensions create supply disruptions.
Bloomberg report on Oil price forecasts by major investment banks
- Raised its 2018 Brent spot forecast to $62 a barrel, up from $58
- Stronger-than-expected commitment by Saudi Arabia and Russia to extend supply cuts during the Nov. 30 OPEC meeting in Vienna were cited for the bank’s bullish view
- Increased its 2018 Brent projection to $60 a barrel from $55
- OECD inventories may fall to five-year averages in the third quarter of 2018, when an informal tapering of the OPEC-led cuts will begin
- Boosted its 2018 Brent forecast to $60 a barrel from $53
- The bank says OPEC, other producer’s “strong commitment” to cuts will lead to “normalized” OECD inventory levels by about the third quarter of next year
- Lifted 2018 Brent forecast to $60 a barrel from $58
- Oil prices have remained “broadly stable, reflecting solid fundamentals and tightening balances,” the bank said. It also cited OPEC and Saudi Arabia’s willingness to balance markets for its bullish outlook
- Forecasts $54 a barrel for Brent next year (NOTE: The bank has kept its current 2018 price forecast unchanged since cutting it from $60 in July, according to data compiled by Bloomberg)
- The current OPEC-led output curbs will last until mid-2018 or the end of the third quarter, but not the end of next year
- Maintained its Brent forecast at $55 a barrel
- The current optimism over prices will encourage at least 500,000 barrels per day of non-OPEC supply growth outside the U.S. each year in 2018 and 2019
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