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Why the Crude Rally Has Fizzled, Continued: Market Analysis Series - Part 2

This is the second of a three-part look at why oil prices have failed to rally despite OPEC’s best efforts at managing supply cuts. Read part 1 here, and then continue with part 3 here.

So, why is everyone so bullish?

Many oil analysts take as a fait accompli that OPEC-led production cuts thus far are key to balancing the crude market. If this is the case, though, why hasn’t it happened yet?

But the bulls say give it time. In the long run, the market will balance.

Everyone knows what Keynes said about the long run (that we are all dead).

That the market is prime for a rally has become gospel truth. But isn’t something so paradigmatic just a little bit risky?

“Oil prices will get better, and you can take that to the bank,” David Purcell, head of macro research at Tudor, Pickering and Holt, said at a recent Dallas conference.

“The market is under-supplied, inventories are back to normal levels by the end of the year, and if you guys don’t drill the Permian too fast, we’re okay,” Purcell said.

But drilling too fast is just what drillers have been doing. According to Platts Analytics RigData, active Permian horizontal rigs now stand at 280, 40% of all U.S. horizontal drilling. The number of U.S. horizontal rigs will likely break above 700 soon, revisiting a number last seen in April 2015, when Permian rigs made up just 25% of the total.

Graph+-+Permian+Looking+Increasingly+Profitable

Calling for $60/b by the year’s end, FGE Chairman Fereidun Fesharaki said at a Fujairah bunkering conference last month that recent price pessimism was overdone and that financial players in the short term were misreading the market.

Many of the banks have been driving this home as well.

While Credit Suisse analysts earlier this month conceded that both Atlantic Basin and Asia-Pacific crude markets are suffering from oversupply — widening price discounts for Asian grades like Russia’s ESPO Blend and Qatar’s Al-Shaheen can attest to that — they also say that it is too early to ditch the idea that just because prices have struggled, the market isn’t rebalancing.

Graph+-+Russia%27s+Asian+Grades+Have+Suffered

Graph+-+Vietnam+Differentials+Down+Sharply

Graph+-+Malaysian+Differentials+Down+as+Well

In fact just two weeks ago, they suggested doubling down.

A key factor to that call, which by now may be considered yesterday’s news, was the risk of supply disruption out of Libya after that country announced a fresh force majeure on exports from its Zawiya terminal.

This news came just before weekly EIA data showed a surprise draw in U.S. crude stocks. The bulls jumped all over this and the market rallied.

But what these analysts failed to notice — or just left out — was the fact that if the Mediterranean was actually tight on crude, differentials for spot grades in that neighborhood, like Azeri Light, CPC Blend and Saharan Blend, would likely have risen.

Graph+-+Med+Sweets+Fail+to+Rally+on+Libyan+Woe

But they have not. They are uniformly at multi-month lows, if not worse.

And to make the recent Libya-trouble-is-bullish angle even harder to justify, some months ago it was thought that perhaps additional volumes from Kazakhstan’s Kashagan were weighing on Mediterranean differentials. At that time, traders and many in-house at S&P Global Platts were skeptical of this.

Here’s the kicker: The weakness, many said, was actually the surprising rebound in volumes coming out of where? You guessed it: Libya.

So how can Libya be both fuel for the bulls’ fire on the futures front, and fodder for bears looking to justify cheaper and cheaper spot barrels in the Med?

When the futures market is rabid for any upside — as one can see from the almost regretful, yet nonetheless real, pullback in net length across the money manager category of the Commodity Futures Trading Commission data over the past few weeks — headlines alone can make or break a day.

Citi analysts have also called the recent market a buying opportunity. Just this week they said that upside can be found as soon as Q2 based on strong OPEC compliance, stagnating Iranian exports, and a seasonal pick-up in crude and product demand.

Fundamental to this call has been the belief that the Saudis will to continue to push for higher prices, rather than focusing on market share.

But earlier this month, Saudi Aramco announced that they would be cutting official selling prices to buyers in Europe and Asia. While U.S. buyers saw a rise, it’s only slightly up from a very sustained and deep trough. The big picture suggests the Saudis are letting the market talk itself higher while ceding very little, if any, market share.

This leads to the following question. Who isn’t getting Saudi barrels?

Surprisingly enough, this is proving difficult to answer.

JODI data shows Saudi exports are indeed falling sharply, and recently Platts reported that Taiwan’s Saudi imports were down. But Japanese refiners have said contractually obligated volumes from Saudi have been met. And this week Platts reported that crude stocks in Japan held by Saudi Arabia and Abu Dhabi jumped 22.8% in February.

Saudi could be cutting to Europe, but that’s in Russia’s backyard and Iran has been looking to lock in more long-term contracts with European refiners. And let’s not forget that the Saudis cutting official selling prices in Europe has long been understood as making a play for more market share, not less.

Recent weekly EIA data shows U.S. imports of Saudi crude had briefly dipped below 1 million b/d for a two week span, but rebounded back above that level last week.

This lines up well with the U.S. customs data analyzed by Platts Analytics’ Bentek Energy, which shows that by using slightly different accounting measures, Saudi imports have not yet fallen by any measurable quantity since the November 30 meeting where output cuts were initially agreed to.

That was exactly 142 days ago. It only takes a cargo of Saudi crude 45 days to make it to the Gulf Coast.

bentek