Crude Oil Update CRUDE OIL

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1 Crude oil prices are trading upside. Conflicting drivers over production trends (US vs. OPEC) as well as intensifying geopolitical tensions led prices on a roller coaster ride. For now, prices pointed upside as geopolitical conflicts as well as fear over potential US sanctions against Iran injected stronger risk premium into oil prices. Brent prices have surged by $10 in a period of one month. The reason for the sudden surge in crude oil prices is more due to geopolitical issues than supply-demand scenario. $/barrels Crude oil prices Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Brent prices WTI prices Recent Upside in prices seen due to following reasons:- Sharp Decline in Venezuela Crude Oil Output - The main development within OPEC has been the sharp decline in Venezuela Crude oil output. It dropped to 1.4 million barrels per day (mbpd) in December-March in 2018 from 1.9 million barrels per day in July-August in This is because of worsening economic crisis, reduction in investment in oil fields and infrastructure over the last couple of years, leading to a steady decline in production and exports. mbpd Venezuela Crude oil production Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Since US financial sanctions were tightened at the end of August 2017, the situation for Venezuela oil has worsened. Some US refiners have reported crude quality issues and have had problems obtaining bank letters of credit. Also some US refiners have decided 1

2 that they are no longer willing to do business with the Venezuelan state oil company, Petróleos de Venezuela, S.A. (PDVSA). The sharp declines in Venezuelan production have helped the rest of OPEC, where output has been broadly steady. Saudi Arabia s Aramco IPO: Saudi Arabia wants to get oil prices near $80a barrel to pay for the government s crowded policy agenda and support the valuation of state energy giant Aramco before an initial public offering. Hence, we are seeing positive statement by Saudi official with regards to extension of production cuts. They have clearly stated at their June 22 meeting 2017, that they would rather be on the side of caution and tighten too much, rather than too little, at its June meeting. This has supported crude oil prices. Geopolitical Risk Premium: On 7th April 2017, the United States fired missiles at the Syrian government airbase. Back then, the severity of the strike was mind-boggling; a total of 59 tomahawk missiles were fired lasting for around 3 to 4 minutes, and described to have severely damaged or destroyed Syrian aircraft and support infrastructure and equipment at Shayrat airfield. Back then, crude oil prices surged near its one-month high beyond its critical $55/bbl handle as market-watchers priced in significant risk premium to oil prices. And as recent as mid-april 2018, a similar missile strike against Syria was carried out again, but with even greater severity. The US assault was described to be twice the size of the 2017 attack, and had its allied forces (including Britain and France) joining the attack against Assad regime s suspected chemical weapon attack on its citizens. Prices moved up by $2 per barrels. Fear of Iran Sanctions: The chance of US waiving oil export sanctions on Iran as required under the multi lateral nuclear deal (JCPOA) by 12th may is supporting the upside in prices. On January 12, 2018, when President Trump waives sanctions, he has demanded that parts of the JCPOA (Joint Comprehensive Plan of Action) known as Iran deal to be rewritten. This threatens oil export sanctions to snap back. The European parties to the agreement have responded by directly talking to Iran about its regional activities and proposing EU sanctions on Iran s ballistic missile program. If EU missile sanctions looks likely and the US and EU make concrete progress towards a possible supplement to the 2

3 deal, then Trump might waive oil export on 12th May, This would cut Iran s crude oil exports by around million barrels per day. This fear is supporting the upside in prices. We have seen through history, geopolitical tensions have more often injected a knee jerk reaction on prices. Fundamentals of the commodity depend upon how demand and supply of the market evolves. For our fundamental outlook this year, we have continued to see strong macroeconomic and oil demand growth, along with continued OPEC productions. While US-led oil production has continued to grow into April, oil inventories seen in both US shores as well as in floating tankers globally has continued to fall. Meanwhile, OPEC-led production has continued to point downwards (OPEC compliance rate is at a high of 170.3% as of March 2018), given the economic issues plaguing Venezuela as well as threats of sanctions on Iran provided the necessary expectations that oil production out from the Middle-East could remain capped for now % % % % % 80.00% 60.00% 40.00% 20.00% 0.00% OPEC COMPLIANCE Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 OPEC COMPLIANCE Source: Bloomberg, Nb research In the figure, we can see OPEC s compliance with production cuts has been well above 100% for the last five months, which shows commitment to drain excess supply from the global market. 3

4 Convention wisdom, however, points at a worrying trend of higher U.S.-led oil production in the horizon. mbpd U.S. oil production Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec no of rigs U.S. Oil Rig Count Jan-2015 Mar-2015 May-2015 Jul-2015 Sep-2015 Nov-2015 Jan-2016 Mar-2016 May-2016 Jul-2016 Sep-2016 Nov-2016 Jan-2017 Mar-2017 May-2017 Jul-2017 Sep-2017 Nov-2017 Jan-2018 Mar-2018 Source: Bloomberg, NB Research According to an analysis of oil-related companies financial statements in Q17, it has been found that US shale oil breakeven price is at a mere $50/bbl, while our estimate is in a range of $40/bbl With oil prices well above $50/bbl to-date, it suggests that efficient shale oil wells are able to churn positive profits for producers, allowing overall rig counts to increase. Importantly, the ability of shale producers to quickly turn supply on and off in response to price moves suggests that further increase in oil prices beyond $70/bbl could result in big increases in supply. Currently, US production is at million barrels per day in March The number of rigs drilling for crude oil in the US has risen to 825 rigs, the highest level since March 2015.The uptick in prices could eventually increase U.S. crude oil production and bring US oil production to 11.5 million barrels per day by the end of Hence, despite strong projected global demand supported by emerging economies like China and India, we are foreseeing problems related to higher US production at these levels. While the rally in oil prices has been present, the most likely upside risks for oil prices involve geopolitical risks and the threat of supply disruptions. As a general comment, our views on geopolitics have evolved. Upside risks continue in countries such as Iran, Venezuela, Libya, Nigeria, and Iraq. In addition to these, there is a growing risk of tensions spilling over to neighbouring countries from Syria. However, the change in our thinking is based on the common thread among many of the oil hotspots, especially in the Middle East. That link is US pullback from its global leadership role, which is particularly evident 4

5 in that region. This allows more assertive policies and actions from countries such as Iran, Russia, Turkey, Saudi Arabia, and Israel. This linkage, due to a common underlying cause, means that instability in various countries and the overall level of geopolitical risk in oil markets may be elevated more persistently than we previously thought. In addition, when supply disruptions do occur, the fact that the inventory overhang has essentially disappeared means that the market reaction may be more pronounced than it has been in recent years. Also if, the US does waive oil export sanctions on Iran as required under the multi-lateral nuclear deal (JCPOA) by 9th May 2018, there could be increase of $3 per barrels in crude oil prices. Oil export sanctions would snap back. This would probably cut Iranian crude exports by around 0.5 Mb/d, not the full Mb/d Oil prices are elevated beyond our comfort zone. The geopolitical premium will play a key role in the prices but we believe even with the geopolitical event, Brent oil prices will have strong resistance at $80 per barrels and WTI to have $74 per barrels. Fundamentally, we expect prices to be under pressure at these levels. In the second half of 2018, we see prices of Brent at $65 per barrels and WTI prices to be at $60 per barrels. 5

6 Research Team Kunal Shah Head of Research Devidas Rajadhikary AVP Commodities Harshal Mehta AVP Commodities Mohammed Azeem Sr. Technical Analyst Ravi D souza Sr. Research Analyst ravi.dsouza@nirmalbang.com Smit Bhayani Research Associate smit.bhayani@nirmalbang.com Shrishty Agarwal Research Associate shrishty.agarwal@nirmalbang.com D isclaimer: This Document has been prepared by N.B. Commodity Research (A Division of Nirmal Bang Commodities Pvt. Ltd). The information, analysis and estimates contained herein are based on N.B. Commodities Research assessment and have been obtained from sources believed to be reliable. This document is meant for the use of the intended recipient only. This document, at best, represents N.B. Commodities Research opinion and is m eant for general information only. N.B. Commodities Research, its directors, officers or employees shall not in any way be responsible for the contents stated herein. N.B. Commodities Research expressly disclaims any and all liabilities that may arise fro m information, errors or omissions in this connection. This document is not to be considered as an offer to sell or a solicitation to buy any securities. N.B. Commodities Research, its affiliates and their employees may from time to time hold positions in securities referred to herein. N.B. Commodities Research or its affiliates may from time to time solicit from or perform investment banking or other services for any company mentioned in this document. Address: Nirmal Bang Commodities Pvt. Ltd., B2, 301 / 302, 3rd Floor, Marathon Innova, Opp. Peninsula Corporate Park, Ganpatrao Kadam Marg, Lower Parel (W), Mumbai , India 6