Oil at US$50

Analysts generally feel that supply disruptions will end soon and that oil prices are unlikely to make further gains

Crude oil drips from a valve at an oil well near Morichal at the state of Monagas on April 16.
Crude oil drips from a valve at an oil well near Morichal at the state of Monagas on April 16. PHOTO: REUTERS

The rebound in oil prices has come much faster than expected but analysts believe the rally has gone about as far as it can, at least for the rest of this year.

Global benchmark Brent crude climbed to a 2016 high at US$52.51 a barrel last Wednesday, up by a sturdy 88.3 per cent from its January low of US$27.88.

The recovery came largely on the back of a series of supply disruptions from Canada to Nigeria, which cut global output by a record 3.6 million barrels a day last month, said UBS Wealth Management analyst Giovanni Staunovo.

"The oil market has probably tightened from a surplus of one million to 1.5 million barrels a day to a temporary balance," he told The Straits Times.

Mr Ole Hansen, head of commodity strategy at Saxo Bank, noted that, at the same time, demand growth in both developed and emerging markets has remained strong despite the overriding concerns about the health of the global economy.

"The rising demand has been met by rising supply from countries like Iran and Iraq, but against this we have also seen a noticeable reduction from producers like the United States," he said. "These disruptions probably added between US$5 and US$10 to oil prices and, as a result, we reached the US$50 level sooner than expected."

Still, the consensus among analysts is that oil prices are unlikely to make further gains, despite having broken past the US$50 level.

Mr Staunovo said the recent supply disruptions will soon come to an end as Canadian production is slowly recovering, while some of the oil flows in Nigeria and Libya have already returned. "Once these disruptions end, the oil market is likely to be still oversupplied."

There is also the risk that the US shale industry, where production costs have fallen substantially in the past years, may step up production in the light of higher prices, said OCBC Bank economist Barnabas Gan. "In fact, with oil now above US$50 (a barrel), some shale oil producers have probably become profitable," he said.

Mr Gan believes that any upside in oil prices will be marginal in the coming months, possibly capped at US$55 a barrel, while UBS' Mr Staunovo similarly expects oil to trade at US$50 by the end of the year and the market will see supply and demand come to a balance next year.

But it will take a long time before any positive impact from higher oil prices trickles down to the broader industry.

Mr David Hewitt, co-head of global oil and gas research at Credit Suisse, noted that having US$50 oil will relieve some of the cash-flow strain for Asia producers, but "we probably need to move to US$60 and beyond before new exploration and development activity becomes more likely".

Platts' associate editorial director Mriganka Jaipuriyar added that the first thing US producers, for instance, are likely to do is repay some of their debt before re-investing in production. "A pick-up in activity is not going to happen overnight. They've laid off people, gotten rid of rigs; logistically, it will also take time, at least a few months," she said.

Down the supply chain, the outlook for offshore marine firms here remains bearish, said Maybank Kim Eng in a report last week, as "most do not expect a meaningful recovery in activities before 2017".

"Asset owners noted that oil companies' 2016 budgets are already set and (they) will focus on completing cost reduction adjustment plans for a lower oil price environment," the report said.

It added that excess supply in the offshore drilling and offshore support vessel segments continues to be an issue.

"We believe that the lagged effect between oil price and return in activities will be more pronounced in this round of recovery," it noted.

"Investors should disconnect oil services players' stock price with oil price as there are no visible signs that the recent oil bounce would filter through to earnings opportunities yet. Instead, we suspect asset impairments are not all done and could persistently upset share prices in the next few quarters."

Mr Gordon Kwan, head of oil and gas research for Asia ex-Japan at Nomura, takes a more optimistic view. He expects oil prices to reach US$70 a barrel by the end of the year, in line with a bullish outlook "due to demand outstripping supply this summer driving season (in the US)", fuelled in part by a weaker greenback.

"We recommend PetroChina Company and CNOOC to ride this sustained oil price rally ahead. In Singapore, we believe short covering will also lift the share prices of Ezion Holdings, Sembcorp Marine and Keppel Corporation," said Mr Kwan.

A version of this article appeared in the print edition of The Straits Times on June 13, 2016, with the headline 'Oil at US$50'. Print Edition | Subscribe