By Nick Cunningham
The oil market is suffering from whip lash. After plunging close to $42 per barrel in late June, and officially entering a bear market, WTI has gained nearly 10 percent in two weeks. By the end of this past week, however, prices were down again.
The latest EIA report offered a lot for oil bulls to like. Not only did crude oil inventories drop by a rather large 6.3 million barrels – one of the largest declines in 2017 – but gasoline storage also declined significantly. In the past, it seemed that every crude draw was largely the result of much higher refining runs, and absent a sharp uptick in demand, that extra oil was spun into gasoline. The end result tended to be an uptick in gasoline storage, offsetting the bullish effect of the crude draw.
But this time, there was no such mitigating data point – the drawdowns in both crude and gasoline storage was met with a warm welcome in the oil market. Oil prices surged more than 1 percent during intraday trading on Thursday, although some of the gains diminished by the day’s close.
Oil storage now stands not all that far above the upper end of the five-year average range, a crucial threshold that OPEC is targeting with its production cuts. Even though everyone was deeply pessimistic about oil prices just two weeks ago, investors were buoyed by the EIA figures last week.
After all, a long list of oil analysts have argued that oil prices won’t start to rally until we start seeing real, tangible declines in inventories. The latest report would suggest that we could be on the verge of just that. The recent price gains are the beginning of a “sustainable rally,” according to recent research note from Ed Morse of Citigroup.
But despite the pop in oil prices on Thursday after the EIA data release, the rally quickly fizzled. By Friday, prices sank further.
There are still a lot of bearish factors out there that could prevent a sharper rise above $50 in the near-term. Although the EIA reported drawdowns in inventories, it also reported a rebound in production figures, dashing hopes that output was on the decline.
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And the sharp price gains over the past two weeks could very likely be the result of a huge wave short-covering by hedge funds and other money managers, who had built up a massive pile of bearish bets by mid-June. Forthcoming data will reveal what has transpired at the beginning of July, but it seems reasonable that many investors closed out short bets as WTI approached the low-$40s, forcing crude back up in short order.
As a result, any further price gains will need to come from the underlying fundamentals. The latest EIA report is a good start, but the drawdowns will have to continue in the weeks ahead.
For now, there are still obstacles preventing that from happening. The market is starting to realize that despite the headline figures regarding the amount of oil that OPEC is taking off of the market, the cartel is still exporting at high levels, minimizing the impact that the cuts were supposed to have. In fact, OPEC exports jumped sharply in June, by a whopping 450,000 bpd. Of course, much of that came from Libya and Nigeria, two countries exempted from the cuts, so the other participants are still mostly complying with their commitments to pare back production. But the market doesn’t particularly care where a barrel of oil comes from – more volume on the market adds to global supply woes.
According to Daniel Yergin, oil historian and vice chairman of market research firm IHS Markit, the lower breakeven prices of U.S. shale on the one hand, and restored output of Libya and Nigeria on the other, will prevent a near-term rebound in prices. “Forget that world of $100 — that was not the new normal; that was an aberration,” Yergin said on CNBC, referring to triple-digit prices in 2014 and the years before. Yergin sees shale production growing even with prices where they are, preventing a rally from occurring for the foreseeable future.
A rally can still only occur, the consensus seems to be, if OPEC makes deeper cuts. As mentioned before, that is probably unlikely, at least unless something more dramatic happens to prices.
By Nick Cunningham of Oilprice.com