Oilfield Magazine


Five fundamentals that dictates oil prices

Five fundamentals that dictates oil prices
April 05
22:32 2016

by: David Sheppard

Output freeze, production, US supply, global demand and hedge fund positioning are crucial factors


Oil’s volatile start to 2016 has continued with prices falling back below $40 as the second quarter begins. The following could determine crude’s next move.

Output freeze

Less than two weeks until a key meeting of Opec members and other large producers, the outcome is very much in doubt.

Deputy Crown Prince Mohammed bin Salman of Saudi Arabia said last week that the Opec kingpin will agree to a hold output only if joined by Iran, something that seems unlikely given Tehran has vowed to lift exports as it emerges from years of sanctions.

Before those comments Opec delegates indicated Saudi Arabia would be prepared to allow Iran some leeway despite the fierce rivalry between the two Middle Eastern powers.

While such views supersede those of the oil ministry, it is possible his message falls short of an edict, and may be partially aimed at a domestic audience used to tough talk against Iran. Equally the comments may be a pre-meeting bargaining chip to extract more concessions from Iran such as capping how much the country raises output before joining the freeze.

Either way, its seems unlikely the world’s largest producers would risk meeting in Doha without a deal already pencilled in. If recent Opec meetings are any guide, a failure to agree a course of action may turn out to be worse than not having sat round the table at all.

“In our view, some sort of compromise agreement is still likely, even without Iran’s full participation,” say analysts at Capital Economics. “However, while a Doha deal might help to set a floor under oil prices, a sustained recovery will probably require outright cuts in global supply as well as further increases in demand to rebalance the market.”

US Supply

The US shale oil boom bears some responsibility for the glut that has decimated prices since mid-2014, but the country’s output is now firmly on a downward trajectory, even as conventional production from areas such as the Gulf of Mexico continues to rise due to investments made back when prices were above $100 a barrel.

Between 2008 and April 2015, US crude oil production almost doubled from 5m barrels a day to a peak of 9.7m b/d. But in the past 12 months it has slipped by at least 5 per cent, with the latest data from the US Energy Information Administration indicating it was below 9.2m b/d in January.

The top 25 US oil and gas producers expect a further production drop of 4 per cent on average this year. By 2017 the EIA expects supply to average about 8.2m b/d for the year — a 1.5m b/d decline from its peak that should go some way towards ending the glut.

Others question such optimism. Energy Aspects, a London-based consultancy, thinks the projected decline in supply may be too high and worries that analysts are extrapolating data from smaller, cash-strapped producers less likely to weather low prices than the majors.

‘’Whilst we expect declines of around 0.5m b/d this year, these may underwhelm those betting on a more significant supply deficit in the second half of 2016,” say Energy Aspects

Have hedge funds had their fill?

Hedge fund positioning has tracked the moves in oil prices so far in 2016. After establishing a near record bet against the price in early January, when crude fell below $30 a barrel for the first time in 13 years, funds have reversed course.

As talk of an output freeze built, funds betting against the price closed out positions, while some entered the market to bet on an eventual recovery. The result? By the end of March, the funds’ net long position — the difference between bets on rising and falling prices — was now close to the highest level on record, the equivalent of more than half a billion barrels of crude.

The outright long position is the highest in history at near 730m barrels.

Rigger Talk

But after prices broke back above $40, the tide may be turning again. Last week traders in Brent and US benchmark West Texas Intermediate reduced bets on higher prices and added to bets on another sell-off. While hedge fund positioning is not the only determinant of pricing, large swings can influence short-term moves.

“Since the lows, crude oil has rallied by more than 40 per cent but most of the recovery has primarily been driven by short-covering,” says Ole Hansen at Saxo Bank. “Despite showing signs of improving, fundamentals are not yet strong enough to support a sustained recovery.”


Low prices can increase the risk of production outages. Baghdad’s long-running dispute with Iraqi Kurdistan over independent oil sales has curtailed output from the north of the country by about 150,000 b/d. In Nigeria, Shell has declared force majeure on about 250,000 b/d of exports after an explosion disrupted its Forcados export terminal.

On the other hand, ahead of the output “freeze” meeting all countries appear to be trying to maximise production. Russia’s output hit a post-Soviet high of 10.9m b/d in March, and Saudi Arabia and Kuwait may restart production at a field in the jointly controlled “neutral zone” that could bring more oil back to the market.

Global demand

Demand is 2016’s wild card. Low prices helped propel global demand growth in 2015, but the picture for this year is more mixed. Concerns about a slowing economy in China have weighed on the outlook; a warm winter reduced demand for heating oil in the northern hemisphere and some expect the effect of lower prices to be more muted this year.

But the International Energy Agency stills sees 1.2m b/d of growth — higher than the average over the previous five years. If that level is reached or exceeded, most analysts expect the market to start to balance towards the end of the year.

“Demand at these levels has been growing strongly,” says Henry Peabody at Eaton Vance, a fund manager. “Non-Opec production is in decline, and capital is not allocated to new projects. We should start to see the market rebalancing later this year or in 2017.”  Source


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