US crude set to weaken in Q1 as support fades

OREANDA-NEWS. December 31, 2015.  US crude futures are set to weaken in the first quarter of 2016 as resilient output and ample supplies overshadow what many had hoped would be bullish factors.

Lifting of 40-year-old restrictions on US crude exports, a sharp drop in crude inventories and reduced drilling activities helped the benchmark post it first weekly increase since late November last week. After four straight sessions of gains, WTI ended last week at the highest since 4 December.

But US output still remains steady despite a sharp decline in the rig count, refinery run rates are already peaking and stockpiles in the storage hub of Cushing, Oklahoma, are at 85pc of their total working capacity of 70.3mn bl — all factors that could cap further WTI price gains.

"The record level of inventories will overhang the market for some time, limiting a recovery in a manner consistent with the 'lower for longer' theme we adopted some months ago," Citi Futures analyst Timothy Evans said. "Downward fundamental pressure would peak in the first half, but further price erosion is possible in the second half too as inventories continue to tick higher."

Based on a technical analysis, UK-bank Barclays said on 21 December it sees room for WTI to slip toward the December 2008 intraday lows of \\$32.48/bl by February, as their bearish view "was endorsed by the break to new lows for the year." Earlier this month, the bank cut its 2016 average for WTI by \\$3/bl to \\$56/bl from a previous forecast made in September.

Apart from US bank Goldman Sachs' bold forecast in September of prices potentially falling to \\$20/bl if storage continues to fill, most major banks and government agencies' WTI projections are within a \\$46-\\$56/bl range in 2016. The US Energy Information Administration (EIA) in its latest Short-Term Energy Outlook (STEO) kept its 2016 WTI forecast unchanged from its previous estimate of \\$51/bl, while revising its 2015 WTI estimate down by \\$1/bl to \\$49/bl.

But analysts at Oppenheimer warned that the industry-wide price consensus is higher "and significantly above the strip." The consensus forecast for WTI is \\$50.84/bl for 2015 and \\$53.18/bl for 2016, versus current strip prices of \\$48.69/bl and \\$39.58/bl respectively, rendering forecasts 4pc above the strip for this year and 34pc higher for next.

"For the consensus forecast to be right, WTI crude price must reach \\$72.60/bl sometime in 2016," Oppenheimer said.

The supply-demand mismatch is overshadowing the US congress' decision to remove restrictions on crude exports, which US oil producers had lobbied for saying it would provide a needed boost to prices. While a global supply overhang meant that WTI prices didn't react much to the decision, the US benchmark settled above Brent for the first time since August 2010 soon after the early December vote. Brent is under additional pressure on expectations of higher shipments from Iran as sanctions get lifted.

"We think lifting the oil export ban is too little, too late and has already been reflected in the Brent-WTI crude price differentials in recent months, which were also impacted by the collapse in oil prices," Oppenheimer said.

A stronger dollar, following the US Federal Reserve's first interest rate increase earlier this month since the 2008-09 financial crisis is also a factor. A stronger dollar weighs on commodities that are priced in dollars, such as oil.

The strains of the market weakness and the bleak outlook are already beginning to show. The number of US oil and gas sector bankruptcies in each of the first three quarters was larger than the total for 2014, according to credit ratings agency Standard & Poor's. Companies that filed for bankruptcy in July-October alone had assets worth \\$6.2bn and liabilities of \\$8.9bn, compared with last year's total asset values of around \\$1bn and liabilities of \\$2bn. Regional US banks face credit downgrades if energy sector loans account for more than 5pc of their total portfolio, S&P said last month.

Producers big and small are lowering spending, refocusing operations and expanding cost-cutting measures. Chevron will cut its capital spending for next year by 24pc to \\$26.6bn, while 2017-2018 spending will fall further, to the \\$20bn-\\$24bn range. ConocoPhillips sold its 50pc operating stake in the Russian Polar Lights joint venture, marking its exit from the country after 25 years, as it offloads non-core assets worth about \\$2.3bn. And Hess said it is pulling out of China's upstream because of market conditions.

"Low commodities prices and uncertainty about the pace of their recovery will continue to limit exploration and production activity in 2016, leading to spending cuts, stalled production growth and volume declines," Moody's managing director of oil & gas Steve Wood said.