Oil Recovery? Likely Just A Flicker

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-US production stubbornly high
-Recent rally not lifting all oil stocks
-Some supply outages only temporary
 

By Eva Brocklehurst

Oils ain't oils. Today, this obscure phrase from an old advertisement is a reminder that the recent rebound in the oil price is not necessarily a prelude to a recovery.

The current oil price, as Deutsche Bank envisages it, may represent a compromise between the threat of market intervention from producers below US$30/bbl and a premature incentivising of US supply at a 2018 forward price of US$62/bbl.

The strength in prices over the past week has been accompanied by a pick-up in both US distillate and gasoline demand, a below average US commercial crude inventory build-up and new lows for the year in the US dollar trade-weighted average.

Yet the fact US production levels are unchanged raises a cautionary note from Deutsche Bank. A renewed boost in oil in floating storage threatens to dampen the market once it is withdrawn. The broker believes these deferred surpluses will enter the market in a matter of months.

Goldman Sachs considers the outlook, further ahead, is more promising. Sure, a fall in non-OPEC supply is needed for the recovery in oil prices to gain traction but such supply is expected to be lower in 2016. US supply is expected to fall by 725,000 barrels per day in 2016 as a result of a sharp fall in rig count and capex budgets.

The broker envisages a West Texas Intermediate (WTI) price in the US$55-60/bbl range in 2017. Yet this is predicated on a modest creep upward in oil prices over 2016 and prices still need to remain sufficiently low so producers do not change their current capital expenditure or production trajectory.

Goldman emphasises that any change in US producer behaviour could delay the impact of a more meaningful recovery in prices and create another self-defeating rally.

Moreover, the broker does not believe the recent rally, or even the improved 2017 outlook, will be positive for all oil equities. For one, it does not sufficiently solve some producer balance sheet problems or address competitiveness. The characteristics the broker is looking for in owning oil stocks are shale productivity gains, resource upside, under-appreciated cash flow and emerging technology.

Stock prices for most Australian oil equities appear to fully factor in a significant recovery in oil prices and, as such, signal a disproportionate risk to the downside, UBS believes. The market remains intent on tracking US oil production. The broker acknowledges a sustained decline may be an indicator that supplies globally are re-balancing, but also notes US production has remained stubbornly high in the face of a falling rig count.

Currently underpinning the oil price are expectations of future stimulus from China, output disruption in Iraq and Nigeria, and key exporters potentially agreeing to a freeze on output. The International Energy Agency also reported declining non-OPEC production. This positive news, the broker maintains, is supporting the oil price above US$40/bbl.

UBS calculates that, including discretionary expenditure, Woodside Petroleum ((WPL)) has the lowest break-even cash flow at US$30.79/bbl while for Oil Search ((OSH)) it is US$33.56/bbl and Santos ((STO)) US$47.09/bbl.

Crude may be becoming overbought, in Morgan Stanley's opinion. There is risk of more hedging, especially by sovereigns, and the broker's FX analysts envisage more strength ahead for the US dollar. Declines in supply may also be overstated, especially if prices rally.

The broker points to several supply outages that may have underpinned the oil price in recent weeks but that are largely temporary. Meanwhile, Iran continues to lift production and US imports from Canada are quietly ramping up.

Morgan Stanley suspects that hedging and storage may cap the upside for WTI in the low to mid US$40/bbl range. Macro fund and short covering are lifting the front of the curve but producer hedging is limiting the rally in deferred prices. High inventories in the US suggest a contango – where the near-term price is lower than the longer-dated price – should remain in place.

Therefore, Morgan Stanley believes the longer-term price outlook will limit to the ability of the short-term price to rally far. The broker envisages WTI capped at US$50/bbl in 2017 and, hence, the price will struggle to break above US$45/bbl this year. While oversupply continues, Morgan Stanley expects WTI to trade in a US$25-45/bbl range.

Another item worth watching is motor vehicle sales in China. Figures for January and February signal a number of disappointing indicators for Chinese gasoline demand, the broker contends. Comparables are particularly worrisome because the current period involved fiscal stimulus that was not present at the same time last year.

Morgan Stanley acknowledges vehicle sales and gasoline demand are not well correlated but believes these weak growth numbers do not augur well, and any deceleration in China or emerging market demand is critical in terms of global balances and the timing of a recovery in the oil price.
 

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