Oil prices remain on defensive

February 19, 2016 09:51 AM

It is always the simple that produces the marvelous.

Amelia Barr 

Oil prices remain on the defensive after moving into negative territory after yesterday’s overall bearish EIA oil inventory report. With the flurry of talks surrounding a production freezing deal between OPEC and Russia both Brent and  WTI are still in positive territory for the week to date (except for the spot Mar WTI contract) with refined products negative for the week. Based on the way the oil complex has traded this week, the market is viewing the deal with a modest level of skepticism from the perspective as to whether a freeze at record-high production levels will accelerate the rebalancing of the global oil market as well as skepticism as to whether everyone abide by the parameters of any deal (especially Russia).

Venezuela and Russia, along with several other OPEC members, have been doing their best to try to convince the market that this deal will make a difference even if Iran does not freeze its production. The only reason OPEC and Russia are discussing a production freeze is because they can’t get any agreement by the key players to cut production. A production cut is what is needed to cap the massive inventory building that is still evolving (estimated at 1.8 to 2 million bpd) and move supply and demand in balance sooner than what most all of the projections are forecasting. Most forecasts currently expect the surplus to last into 2017 even with a modest downturn in non-OPEC production as a result of a low oil price environment.

As I mentioned in the newsletter this week, a production freezing deal could result in oil prices setting a bottom in anticipation that this deal might be the first step in further cooperation that could eventually lead to a production cut by key producers to go along with the attrition cuts expected for non-OPEC producers like the U.S. shale sector. That falls into the category of a perception view ora  view that the market will improve or rebalance in a reasonable period of time. The perception view is what drove oil prices significantly higher throughout 2009 after the financial crisis led to a collapse in oil prices in 2008.

However, with the current and projected fundamentals still forecast to remain surplus though 2016 and into 2017, the reality view will be in conflict with the perception view. For now each time the perception view drives prices higher the market will revert to a reality check, and as long as the reality of the situation is bearish any uptrend will be limited and short lived, as we already saw this week after the bearish EIA inventory snapshot.

Going forward, I expect the market to be in a battle between perception and reality with reality likely to have the upper hand unless the evolving production freeze deal gets more participants and presents itself as something that can in fact lead to additional steps in the future. I expect any rallies in the short term to be shallow and short lived and primarily a result of short covering and not driven by a flurry of new longs coming back into the market. I also expect the more aggressive participants to view each rally as an opportunity to set new shorts at higher levels.

If reality continues to dominate it means that the market will still be looking for a lower price threshold that will accelerate the rebalancing process since voluntary cuts via a more stringent deal are not yet emerging. We already know that the $30/bbl price environment is still not low enough for supply to return back into balance in a reasonable period of time. Thus if reality remains in charge, the market is likely to re-test the lows made a week or so ago and possibly go even lower until the financial pain of lower prices accelerates production cuts over and above what is already projected either in OPEC and/or in non-OPEC countries.

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Energy Market Analysis is published daily by the Energy Management Institute 1324 Lexington Avenue, # 322, New York, NY 10128. Copyright 2008. Reproduction without permission is strictly prohibited. Subscriptions: $129 for annual orders. Editor in Chief: Dominick Chirichella, Publisher: Stephen Gloyd, Editor Sal Umek.