The Recent Oil Price Rally Can’t Be Justified

• Oil prices finally broke the much-talked-about $80 mark this week, but according to the Standard Chartered commodities desk that is a level that can’t be justified

• Rising U.S. production and a possible release of U.S. strategic reserves could well drive oil prices down in the coming weeks

• The recent oil price rally appears to have been driven more by technical factors than any fundamentals 

After a fairytale run that saw Brent temporarily cross the magical $80/bbl mark for the first time in three years, the crude rally has taken a breather thanks to a surprise build in crude inventories. On Tuesday, the American Petroleum Institute (API) reported a build in crude oil inventories of 4.127 million barrels for the week ending September 24, contrary to analysts’ consensus of a loss of 2.33 million barrels. API had reported a draw in oil inventories of 6.108 million barrels in the previous week, well above expectations of a draw of 2.40 million barrels.

Nevertheless, Brent settled at USD 78.17/bbl on 30th September for a w/w gain of USD 4.25/bbl, while WTI for November delivery rose USD 4.11/bbl w/w to USD 74.25/bbl. 

Despite the latest surprise build, it’s worth noting that oil inventories in the United States have drawn down nearly 73 million barrels so far this year - well below pre-pandemic levels. The latest data by the U.S. Energy Information Administration (EIA) suggests that crude oil inventories in the United States are now 8% under the five-year average for this time of year, at 414 million barrels.

The Standard Chartered commodities desk has offered a rather bearish oil price outlook, arguing that the fundamental case for USD 80/bbl is not any stronger today than it was a few months ago.

The technical side

According to Stanchart strategists, the move in Brent seemed to come straight out of a technical trading textbook; the market had held key support last week and then recorded a double inside day (consecutive days of lower highs and higher lows) before exceeding the 2021 high and breaking out further to the upside.

The move higher also reflected developments in broader risk asset markets, in particular mirroring the market for 10Y US Treasuries. The gains continued along the oil price curve, with further-out values reversing their recent weakness. Brent for delivery five years out gained USD 2.61/bbl w/w, settling at a three-month high of 59.66/bbl on 27 September. Oil prices broke out to the upside, with Brent pushing above USD 80/bbl thanks to highly positive technical factors and supportive cross-asset developments helped the move to USD 80/bbl stick this time, in contrast to the stalled push higher in early July and the subsequent weakness. In the 12 weeks since the failed push higher, prices swung lower by USD 13/bbl before rallying USD 16/bbl back towards USD 80/bbl. 

Stanchart, however, says it remains skeptical that the fundamental case for USD 80/bbl is any stronger today than it was in early July. Indeed, the analysts say market balances have weakened in the intervening period. Market expectations of a strong global stock draw in July were not met, and August and September appear to show slight global surpluses, with global demand having remained flat since June.

The positive shift in market sentiment about oil fundamentals appears to be a crossover from the strength of international gas markets, particularly the sensitivity of markets to a potentially colder-than-normal northern hemisphere winter. Despite mixed weather forecasts, Stanchart says the market may be pricing in lower-than-average temperatures and overstating the boost to oil demand from substitution for gas. In all, significant weather risk appears to be embedded in current prices. 

Comparing medium-term weather forecasts to the colder conditions the market is pricing in, the associated price risk appears to be to the downside.

Biden administration intervenes

With the next OPEC+ meeting scheduled for 4th October, the big question at this juncture is whether ministers will want to be seen to be doing more to cap prices.

Back in August, Biden exhorted OPEC+ to do more to control prices at a time when Brent was about USD 8/bbl lower than current levels. That intervention came just after an OPEC+ meeting and seemed to be primarily intended for a domestic U.S. audience. According to Stanchart, the Biden administration is likely to have repeated this point privately to key producers in advance of the upcoming OPEC+ meeting and will be expecting more of a response than it got in August when OPEC+ declined to increase output. Related: Commerce Department Delays Critical Decision On Solar Panel Tariffs

Indeed, the analysts say there’s a fair chance that the administration will authorize the release of the strategic oil reserve should OPEC+ disappoint again and prices continue climbing. In August, for the first time in four years, the Energy Department authorized the release of some of its strategic oil supply to combat a significant fuel shortage in Louisiana following Hurricane Ida.

Rising production

Something else to keep an eye on is rising oil production.

U.S. oil production had been down more than a million bpd over the last couple of weeks, but crude production ticked up for the week ending September 17, to 10.6 million bp–with more than 84% of Gulf of Mexico oil producers finally back online after Hurricane Ida made landfall at the end of August. 

The U.S. oil rig count rose by 10 w/w to a 17-month high of 421 for the week ended 24

September, according to the latest Baker-Hughes survey, marking the first consecutive

double-digit increase since April 2017. Four of the 17 Louisiana rigs idled by Hurricane Ida became active again (three offshore and one onshore), leaving nine rigs still inactive.

In areas unaffected by Ida, the main w/w gain was Oklahoma’s four rig increase, taking the state’s oil rig count to 38.  Within the Permian Basin of West Texas and New Mexico, the Delaware Basin rig count rose by two, while the Midland Basin rig count fell by one, and other Permian activity was unchanged at 21 rigs.

Meanwhile, Libya remains a wildcard, with Libya’s Minister of Oil and Gas, Mohamed Oun, recently announcing that the country’s crude oil production has risen to 1.3mb/d, the highest since April 2013. The Libyan government aims to raise production rapidly, although this will

require investment to upgrade and maintain facilities damaged by war and chronic

underinvestment. Libya remains exempt from OPEC+quotas, so any increases in production will be additive to OPEC+‘s current clip of 400,000 b/d per month.

By Alex Kimani for Oilprice.com

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