Oil prices fall as OPEC has no positive surprise up its sleeve
Oil prices fall as OPEC has no positive surprise up its sleeve. OPEC and its non-OPEC partners have agreed to freeze production at current levels for another nine months. Current production levels are approximately 1.8mn barrels per day lower than they were in October 2016, if the output figures are to be believed. The market has been led to believe that this would be the likely outcome from the meeting after the major players had already announced that a nine-month extension was palatable. With the market conditioned to expect surprises emerging from the “smoke and mirrors” format of OPEC meetings, the result of the current meeting has been an anti-climax.
The Saudi-Arabian led cartel has sought to bolster prices after the price collapse that emerged when its 2014 experiment failed and crippled many OPEC member economies. Saudi Arabia wants to sell part of its state oil company to boost its financial coffers, which is the chief reason why it wants oil prices to trade above US$50/bbl. Other members have followed and sacrificed production as higher prices have helped turn revenues around. However, revenues are unlikely to reach levels these countries are accustomed to.
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Oil continues to trade in a tight range with the upper bound at US$55/bbl. As we argued in “OPEC’s choices: double down or do nothing”, a deeper cut would be need to shock the market to drive prices higher. With US, Canadian and Brazilian production continuing to grow and global demand remaining soft, global oil inventories will remain elevated. OPEC’s target of bringing down the level of OECD oil inventories to its 5-year average will continuingly be undermined by the growth in US shale oil.
Driven by the price war that OPEC initiated in 2014, US shale oil players are leaner than they have ever been and can make profit at considerably lower prices than in 2014.
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At current prices we expect US production to grow. Rigs are considerably more efficient than they used to be. The US is close to producing record amounts of oil with almost half the number of rigs as there were at the peak in 2014. Persistent and nimble US producers are likely to continue to undermine the efforts of OPEC. In the absence of a deeper cut, we expect prices to continue to grind lower, possibly below US$50/bbl.
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We expect OPEC compliance to its agreement to fade as has historically been the pattern. With Saudi Arabia having the most to lose from a collapse in the deal, we expect other members to free-ride on its efforts to keep a lid a production. As other members question what will happen after the Saudi Aramco IPO, we doubt the notion of ‘solidarity’ is as strong as being portrayed in front of the press. Although Russia, the largest non-OPEC member in the deal, claims to have been cutting more than is needed, it contradicts the data in the OPEC monthly reports.[1] As compliance comes under greater scrutiny, prices are likely to weaken. We continue to believe that oil will range trade between US$40-55/bbl.
[1] In OPEC’s November report, Russia was producing 10.59mb/d in October and in OPEC’s May report, Russia was producing 10.39mb/d in April. That only amounts to a 200k b/d cut, compared to the 300k b/d Russia signed up to for each month.
Nitesh Shah, Research Analyst at ETF Securities
Niteshis a Commodities Strategist at ETF Securities. Nitesh has 13 years of experience as an economist and strategist, covering a wide range of markets and asset classes. Prior to joining ETF Securities, Nitesh was an economist covering the European structured finance markets at Moody’s Investors Service and was a member of Moody’s global macroeconomics team. Before that he was an economist at the Pension Protection Fund and an equity strategist at Decision Economics. He started his career at HSBC Investment Bank. Nitesh holds a Bachelor of Science in Economics from the London School of Economics and a Master of Arts in International Economics and Finance from Brandeis University (USA).
OPEC’s current strategy is not working. Oil prices have given back nearly all their gains since the cartel agreed to cut production in November 2016. We believe the credible options for their next move, to be discussed at their May 25th meeting, will be to either to cut deeper or let the deal collapse. The latter option seems the most likely outcome. OPECs choices, double down or do nothing.
As we argued in our recent outlooks, the efforts of OPEC members with assigned quotas, are being undermined by:
1. the growth in supply from the OPEC members who don’t have quotas 2. non-OPEC members participant to the deal that are not adhering to it 3. the rapid growth in supply from other countries, most notably the US
Today’s release of OPEC’s Monthly Oil Market Report acknowledges the extent to which supply from the US, Canada and Brazil is set to rise.
We therefore believe that repeating the same strategy for another six months will do little to shore up oil prices. OPEC nations have given up market share and have barely reaped any price gains. Given that consensus expectations are for a simple deal extension (i.e. that is what is currently priced-in), following the status quo is unlikely to be met with a positive price response. We believe that if OPEC is serious about getting the market to balance it will have to cut deeper in order to ‘shock’ the market and drive prices higher. Sacrificing volume requires higher prices.
However, gaining a consensus agreement on a bolder move will be difficult. The smaller and more financially constrained members will be reluctant to give up more volume. Saudi Arabia is vocally supportive of a deal extension. But if Iran insists on being able to increase production further while Saudi Arabia has to bear the brunt of further production cuts, the deal’s flaws will become even more accentuated. We believe that doing nothing and letting the deal collapse will be default option in the event that the cartel is unable to gain support for a deeper cut.
While OPEC surprised on the upside at its November 2016 meeting by coming to an agreement, we believe the May 25th 2017 meeting will surprise on the downside with a lack of agreement. In such event, oil prices could decline close to US$40/bbl (from US$48/bb currently), which we believe is the structural floor for oil prices, set by the breakeven price of US shale oil production.
Nitesh Shah, Research Analyst at ETF Securities
Niteshis a Commodities Strategist at ETF Securities. Nitesh has 13 years of experience as an economist and strategist, covering a wide range of markets and asset classes. Prior to joining ETF Securities, Nitesh was an economist covering the European structured finance markets at Moody’s Investors Service and was a member of Moody’s global macroeconomics team. Before that he was an economist at the Pension Protection Fund and an equity strategist at Decision Economics. He started his career at HSBC Investment Bank. Nitesh holds a Bachelor of Science in Economics from the London School of Economics and a Master of Arts in International Economics and Finance from Brandeis University (USA).
US planting of wheat and corn are down as weak prices deter farmers. Soybeanand cotton planting rise as US farmers hope to continue last year’s increase in exports.
The latest USDA Prospective Planting report shows that farmers are responding to price signals from last year. Wheatplanting is down 8% to the lowest level since records began in 1919. Corn planting is expected to be down 4%. Both of these crops saw record high output last season, which sent wheat and corn prices tumbling 18% and 17% since June 2016. However, to move prices meaningfully higher, other countries will have to restrain planting and the gains in yields we have seen in recent years will have to abate.
Soybean on the other hand is expected to see a 7% rise in planting this season. Last year, a poor South American crop increased demand for US soybean and lent support to its price. US soybean exports rose 4.5% in 2016/17. Although prices have eased in the past month, US farmers are hoping to take further market share this season.
Cotton planting is expected to rise by 21%. That comes as cotton prices have increased 28% in the past year and US exports rose 44% in 2016/17. Cotton has been in a supply deficit for the past two years and US farmers appear to be banking on continued tightness. However, global cotton inventories ex-China have not fallen and remain around the average in the past 10 years. China’s surplus inventory has been declining as the country abandoned it stockpiling programme in 2014. However, China’s imports of cotton may remain restrictive. US farmers will have to rely on growth in imports elsewhere to absorb potential increased production.
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Nitesh Shah, Research Analyst at ETF Securities
Niteshis a Commodities Strategist at ETF Securities. Nitesh has 13 years of experience as an economist and strategist, covering a wide range of markets and asset classes. Prior to joining ETF Securities, Nitesh was an economist covering the European structured finance markets at Moody’s Investors Service and was a member of Moody’s global macroeconomics team. Before that he was an economist at the Pension Protection Fund and an equity strategist at Decision Economics. He started his career at HSBC Investment Bank. Nitesh holds a Bachelor of Science in Economics from the London School of Economics and a Master of Arts in International Economics and Finance from Brandeis University (USA).
Investors sell gold as hawkish Fed sends the price lower. There was US$96.3mn of outflows from long gold ETPs last week, marking the first weekly outflow in five weeks. Following hawkish rhetoric from the Federal Reserve last week, investors changed their view about the timing of the central bank’s next rate move. The Fed Fund futures implied probability of a rate rise this month went from 40% at the beginning of the week to 90% by the end of the week. Better-than-expected ISM manufacturing, consumer confidence, durable goods orders and core PCE inflation data released last week was seen to provide the Fed ammunition. A strong reading in this week’s payroll data may give another reason for the Fed to move higher at its March 15th meeting. While gold held steady in the first half of the week amid the burgeoning political risks around Europe, Macron’s announcement of his policy platform unwound part of the ‘fear trade’ as markets cheered on his centrist appeal. Gold ended the week 1.8% down. We still believe that even if the Fed raises rates this month, elevated inflationary pressure will keep a lid on real interest rates, which will be gold price supportive in the first half of the year.
Technology themed equity ETPs continue to gain favour. Inflows into robotic and cybersecurity themed equity ETPs continued unabated last week with US$7.9mn into robotics and US$16.2mn into cybersecurity ETPs. Inflows into cybersecurity were at their highest since inception.
Buying crude oil on price dips. We saw the first weekly inflows into crude oil ETPs in five weeks as investors bought US$20.9mn of long oil ETPs on a price dip of 1.2%. Despite OPEC’s efforts to cut production, US oil continues to grow and inventories are elevated, weighing on oil price.
Investors diversify within industrial metals. While investors sold US$15.5mn of nickel and US$12.5mn of zinc ETPs, they bought US$15.9mn of diversified industrial metal basket ETPs. Picking the individual winners in industrial metals appears more difficult when prices are so volatile, but the broad theme of tightening supply and rising demand is set to benefit the commodity sub-sector.
Largest inflows into short FTSE ETFs since July 2016. Inflows into short FTSE ETFs of US$5.8mn were the highest since the post-referendum month of July 2016. As the House of Lords rejected certain parts of the Brexit Bill, the market is preparing for continued tussles between the government and the second chamber of parliament.
Video Presentation
Nitesh Shah, Director, Commodity Research at ETF Securities provides an analysis of last week’s performance, flow and trading activity in commodity exchange traded products and a look at the week ahead.
For more information contact
ETF Securities Research team
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Chocolate makers to benefit from cheaper cocoa prices
Cocoa is expected to go back into a supply surplus this year. The surplus will be highest in six years and will weigh on prices. Confectioners, who only last year were reducing the chocolate content of their bars, may be less thrifty this year. Chocolate makers to benefit from cheaper cocoa prices
Favourable weather has promoted a good cocoa crop this year in Africa. 70% of global cocoa comes from Africa. The main crop, which contributes to about 80% of the total annual harvest in Africa is be complete in March. The International Cocoa Organization (ICCO) yesterday released its supply and demand forecast for 2016/17, showing a return to a production surplus. Seasonal ‘Harmattan’ winds that threaten to damage the crop failed to materialise and its absence has reversed the supply deficit that the market had initially assumed. Cocoa prices have fallen by 40% and speculative positioning has fallen to an all-time low.
The ICCO forecasts that supply will increase by 14.8% to an all-time high of 4.6 million tonnes in 2016/17. Meanwhile demand will only rise 2.9% to 4.2 million tonnes.
Near-term pressures remain on cocoa prices. While port deliveries of cocoa at Ivory Coast have not risen substantially yet, that is due to a disruption with exporters. A number of local exporters who bought cocoa – expecting its price to rise – have defaulted on contracts. That cocoa is piled in warehouses, waiting to be re-auctioned. Once that cocoa is sold the elevated output is likely to enter global supply.
Following the dramatic 40% decline in cocoa prices since August 2016, we believe that demand could make a stronger comeback this year than the ICCO anticipates. In 2016, a number of confectioners reduced the cocoa content of their chocolates in an effort to reduce their costs amid high cocoa prices. Now that cocoa prices have declined, we could see a reversal of that strategy. Consumers concerned that that their Easter eggs will be light on chocolate need not worry with prices this low.
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Nitesh Shah, Research Analyst at ETF Securities
Niteshis a Commodities Strategist at ETF Securities. Nitesh has 13 years of experience as an economist and strategist, covering a wide range of markets and asset classes. Prior to joining ETF Securities, Nitesh was an economist covering the European structured finance markets at Moody’s Investors Service and was a member of Moody’s global macroeconomics team. Before that he was an economist at the Pension Protection Fund and an equity strategist at Decision Economics. He started his career at HSBC Investment Bank. Nitesh holds a Bachelor of Science in Economics from the London School of Economics and a Master of Arts in International Economics and Finance from Brandeis University (USA).
