Oil: Volatility is the norm

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Tamer El Zayat

The recent daily and weekly gyrations in oil prices have made it extremely difficult to ascertain the trends and factors at play, with some analysts focusing on the winding/unwinding of speculative positions.
Yet, fundamentally-speaking, elevated production levels, decelerating demand, and record high inventories have been the drags that suppressed oil prices around a tight range of $26-$36 per barrel (bbl) during the last couple of weeks.
Growth dynamics pertaining to emerging markets, in particular China, and production factors relating to OPEC have underpinned the bearish views and the lower-for-longer expectations of many analysts observing the energy space.
The lack of compliance among OPEC members that produced above the 30 million barrels per day (mbd) quota for the 20th month in a row remains a drag, especially that the group lacks a unified front.
Iraq and Iran are adamant in producing as much as they can to make up for the lost years, a situation that is materializing with Iraq increasing its output that had reached 4.25 mbd this January, around 0.9 mbd higher than levels witnessed in early 2015.
Lifting the sanctions imposed in July 2012 on Iran is also expected to bring an additional 500 thousand barrels a day during 1H2016, which will keep OPEC’s production above the 32 mbd mark.
As such, and given the expectations of more supply going forward, the Kingdom and Russia’s initiative to freeze production at January levels received a muted market response, with market participants preferring a meaningful cut instead, especially that both countries are producing above the 10 mbd mark, a multi-year high.
Even though non-OPEC members and high-cost producers will continue to be pressured this year, the anticipated decline in their production will not offset OPEC’s over quota reality.
The IEA, EIA and OPEC have forecasted a decline in non-OPEC supply by around 600,000 barrels a day, the first annual decrease since 2008, largely due to the steeper decline in US shale production.
The IEA predicted in its latest report that companies operating in US shale formations will reduce production by a record 600,000 barrels a day, which underscores the challenging environment even after slashing capital spending, laying off workers and focusing on the most productive areas.
Nevertheless, their ability to maintain elevated levels of production despite the 80 percent plunge in rig counts is a testimony of their technical prowess and ability to turn the taps once oil prices recover.
On the demand side, China is expected to moderate, with growth remaining below 7 percent for 2016 despite the myriad attempts to reduce interest rates, reserve requirements and devalue the Yuan in order to spur business activity.
Furthermore, emerging markets are expected to expand at 4 percent, the slowest pace since 2010 and well below their 10-year average of 7 percent.
Oil demand is forecasted to rise by 1.2 mbd in 2016, much slower than last year that saw demand grow by as much as 1.8 mbd, a five-year high.
The record US and global crude oil inventories will also continue to weigh on oil markets.
US crude oil inventory at 507 mbd is 31 percent more than the level recorded in 2014, which was 388 mbd, and is also an all-time high. Additionally, the OECD’s commercial total oil inventories crossed the 3 billion barrels, equivalent to 60 days of consumption and above the five-year average.
In my opinion, the aforementioned dynamics will make it a challenging year for crude, so expect intense volatility ahead, still a norm for those that have been observing oil markets since 2008.

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