Article / 09 August 2017 at 11:00 GMT

Oil torn between rising output and falling inventories — #SaxoStrats

Head of Commodity Strategy / Saxo Bank
Denmark
  • Crude oil prices have settled into tight range after surging on short-covering in July
  • Upside for oil is capped by rising US and Libyan output
  • In 5 weeks to Aug 1, hedge funds boosted Brent and WTI net long by 294m barrels
  • EIA inventory report due at 1430 GMT
Oil pump jack and pipeliines
 Oil prices are trapped between rising production and falling inventories. Photo: Shutterstock


By Ole Hansen

Crude oil has settled into a relatively tight range after surging in July. The rally last month was driven by short-covering as the Saudis cut exports and US inventories decline further. The upside, however, remains capped as rising production in the US and Libya are likely to offset these continued inventory and export declines. The market awaits fresh inventory data later today from the US Energy Information Administration.

Lower compliance and a strong pick-up in Libyan production were the two drivers that sparked this year's third short-selling cycle back in June. During that month, the gross short position held by hedge funds in Brent and WTI crude oil hit the second highest on record. Come July and the above-mentioned export cut and falling inventories left the market vulnerable to short-covering, and a short squeeze followed.

During the five-week period to August 1, hedge funds increased the combined net long in Brent and WTI crude oil by 294 million barrels. Fresh buying added 102 million barrels, while the short position was cut in half by 192 million barrels.  Last week's 101 million barrel net increase was the biggest weekly addition since early December when Opec and Non-Opec producers announced their joint initiative to curb production. 

Speculative positioning in Crude oil
Having seen WTI return to $50/barrel and Brent getting close to our third-quarter target of $55/b, it is worth once again taking a look at what is required to maintain the recent recovery in oil: 
  • Slowing US rigs and production growth in response to lower prices  
  • Strong seasonal reduction in US crude oil stocks (normally runs till end-September)  
  • Opec maintains discipline, especially from Iraq and Iran. Reduce visible exports (ex. USA)  
  • Slowdown in or renewed disruptions to production growth from Libya and Nigeria.  
  • Geopolitical event

US crude oil inventories look set to show a sixth consecutive weekly decline later today when the EIA publishes its weekly update on stocks, flows and production. As the charts below show, both crude oil and the total oil and product stock have moved within their five-year range, but remain well above the long-term average. 
 
DOE data
Crude oil production reached a new two-year high last week at 9.4 million b/d. The EIA in its latest Short Term Energy Outlook raised its 2017 average production forecast to 9.35 million b/d and lifted its 2018 forecast up to 9.9 million b/d. 

Adding the recent increase in production from Libya and Nigeria, we see Opec's dilemma and why it is important for the cartel to maintain discipline on capping production while cutting visible exports. US imports from its three major Opec suppliers have yet to show any signs of slowing, according to the chart above.
Opec dilemma



















While bulls are building a long position (again), the market is still likely to remain range-bound for now. Alternating focus between rising production and falling inventories could see WTI crude oil maintain a short-term trading range between $47 and $50.5/b.

WTI crude oil, first month cont.
 Source: Saxo Bank


— Edited by John Acher

Ole Hansen is head of commodity strategy at Saxo Bank 
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Latest Bloomberg survey including API result from yesterday
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EIA result and reaction: A 6.4m bbl reduction in crude oil inventories (on lower imports) being offset by a 3.4m bbl rise in gasoline. Production dropped 7k bbl due to Alaska
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Imports from key Opec members showed a 1m b/d drop to second lowest since Feb 2016
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