WTI oil prices are flat year-to-date after having seen the best start to a year in over a decade and reaching a 3-year high of USD 66.5 in mid-January. At the beginning of February, oil prices tumbled by more than 8% to USD 60.5 on the back of worrying news about supply/demand fundamentals.
On the supply side, the market was alarmed by recent data that showed US oil production at an all-time high of 10.25 million barrels a day. Additionally, US crude oil inventories have stopped falling in the past 2 weeks, breaking a momentum of 10 weeks of decline and denting OPEC objectives of reducing inventories to a 5-year average. Last but not least, more than 29 oil rigs have been added in the last month reaching the highest level since April 2015, indicating a potential strong medium-term surge in the crude oil supply, coming predominantly from the US Permian Shale producers. The increase in rigs comes at a time when concerns about a major production spike are at a high level in the wake of the recent data from the Energy Agency, translating into a major hit to market sentiment. Investors remain unconvinced that US producer discipline will hold and it seems they might be proved right.
Demand is still healthy in the US and Chinese imports are at record highs with a positive outlook in the long term. China’s oil imports are now the largest in the world and are continuing to increase with strong demand growth and constant domestic crude production. The trend for larger cars (SUVs represent 40% of new sales) and the penetration of car ownership continue to drive Chinese demand. Additionally, we are still confident that demand growth in India could provide upside surprises.
Geopolitical appeasement has also contributed to the drop in oil prices, and we saw the recent risk premium associated with potential supply disruption erode. Looking at Saudi Arabia, the de facto leader of OPEC, both the domestic political “purge” and the Saudi-Qatari feud seem to have been scaled back, thus increasing the sustainability of the OPEC-led effort to cut global oil production while at the same time removing some of the risk premium on oil prices. The decrease in negative newsflow from major oil producers such as Venezuela and Iran have removed a big support to oil prices.
Despite the recent correction, the commodity price remains well above the average cash flow break-even level of integrated oil companies; these companies have been relatively resilient during the recent price correction. Looking at the earning season for the oil supermajors, Europe clearly outperformed the US with strong numbers in the upstream and mixed results in the downstream. Share buy-backs have also been announced across the board for the large, integrated, European companies with the aim of reducing the dilution experienced by shareholders in the last couple of years.
Pierre Melki
Equity Analyst Global Equity Research