Crude Oil Price Analysis for August 14, 2017

Crude oil prices rebounded from session lows, as riskier assets rebounded following Thursday’s surge in volatility in the wake of the standoff between the White House and North Korea.  The IEA reported an estimate of rising demand, following the release of data that showed that OPEC produced more oil than expected in July.

Technicals

Crude oil prices were slightly lower on Friday, after testing support near an upward sloping trend line that comes in just below the low of the session at 48.60.  Resistance on crude oil prices is seen near the 10-day moving average at 49.27. Momentum has turned negative as the MACD (moving average convergence divergence) index generated a crossover sell signal. This occurs as the spread (the 12-day exponential moving average minus the 26-day exponential moving average) crosses below the 9-day exponential moving average of they spread. The index moved from positive to negative territory confirming the sell signal. The MACD histogram is printing in the red with a downward sloping trajectory which points to lower prices for crude oil.

Product Demand is Spilling Over into Crude Oil Demand

Strong demand for products, has kept refineries in the United States busy, and despite a slight dip in gasoline demand, it is still pushing up against the 10-million barrels a day level. In fact, the heating oil crack has reached a 2-year high, driving refineries to produce more. The robust increase in demand for distillate and jet fuel have pushed crude oil refinery inputs to 17.6 million barrels per day during the week ending August 4, 2017, 166,000 barrels per day more than the previous week’s average. Refineries operated at 96.3% of their operable capacity. While gasoline production increased slightly last week, averaging 10.3 million barrels per day, distillate fuel production increased last week, averaging 5.3 million barrels per day.

This means that demand for oil is increasing which was confirmed on Friday by a forecast released by the International Energy Agency. They say that the Oil market is re-balancing as demand continues to grow. The IEA forecasts that global oil demand is expected to increase by 1.5 million barrels per day this year, revising up its July forecast from 1.4 million. This momentum is then expected to continue into 2018, when demand is seen growing by a further 1.4 million.

The increase in demand should absorb excess supply, but OPEC members know this and the desire to cheat especially for those who recently experienced sanctions it palpable. The continued output expansion by Libya and Nigeria, the two OPEC members exempt from the efforts, as well as from U.S. drillers, means that the re-balancing could take a while.

Output Remains Strong

OPEC output jumped in July by 173,000 barrels a day to almost 32.9 million barrels, its highest level since the production agreement came into force in January. Compliance with the deal by OPEC members currently stands at 87% according to the IEA.

Additionally, to counter demand, the EIA expects U.S. crude oil production to increase to an average of 9.3 million barrels per day in 2017. EIA forecasts crude oil production to average 9.9 million barrels per day in 2018, which would mark the highest annual average production in U.S. history.

So, while demand remains robust and continues to help prices remain buoyed, there are production influences that continue to erode this dynamic, which is why oil prices remain rangebound.

The Futures Curve Points to higher Prices

Crude oil prices in the future are pointing to a tightening market. When demand is weak and supply is plentiful prices in the future are higher than current prices. Well the difference has recently evaporated. When prices in the futures are higher than current prices, the market is in contango which has basically disappeared. In fact, it might invert which is called backwardation. This  would not only lead to stronger inventory declines, but it would make it uneconomical to hedge at lower levels, which would disrupt the model that is used by the U.S. shale drillers who typically lock in a certain portion of their production a year ahead of time, which insulates them from another downturn.

Backwardation would upend that calculation. If all shale drillers have to go by is a futures price that is actually lower than today’s price, then the incentive to hedge is much diminished. That could translate into spending cuts, more modest drilling programs, and ultimately, lower oil production in 2018. Without the certainty of locking in production with hedging, it would be much riskier for these drillers to move ahead aggressively. To sum up, a shift into backwardation could slow the growth of shale to some extent.