Oil prices rallied in the recent consecutive three quarters
In 1H18, both of the WTI and Brent crude oil prices were riding on the tailwind of shrinking inventories, and Brent hit a more than 3-year highs of US$80/bbl in Jun-18. According to US Energy Information Administration (EIA) Short-term Energy Outlook in Jun-18, the excess US crude inventory has been depleting over the past three quarters, see Figure 2, indicating the supply glut had been gradually diminishing since Jul-17. Another positive is during the recovery period, oil market turned from contango to backwardation (current oil supply level is lower than expected). A reflection that spot demand is strong. The status will probably persist as stockpiles are moving downward, as shown in Figure 4. Meanwhile, EIA forecasted supply-demand dynamic will remain at a relatively balanced level in the next three quarters. Therefore, we believe oil prices will be supported at above US$70/bbl.
The resumption of elevated output is confronting to several limits
With the increased likelihood of sanctions on Iran, the global oil market is under the pressure of future supply shortfall. As of May-18, Iran’s production was 3.8mn bbl/d. Meanwhile, US has urged Saudi Arabia to increase output by 2mn bbl/d. This will be challenging as Saudi Arabia mentioned this spare capacity is expensive to turn on. See Figure 5, the OPEC capacity was below 3mn bbl/d as of May-18, indicating that there is little room for OPEC to pump more oil on a larger scale. For the US, it had been increasing production, reaching a new record of 10.9mn bbl/d as of Jun-18, as shown in Figure 6. However, the production could encounter bottlenecks such as a in pipeline capacity, obsolete infrastructure and lack of workforce. Hence, US production growth may slow down in the near term. In a nutshell, the resumption of lifting global oil supply could be outstripped by the stronger demand.
Offshore drilling activities are recovering but day rates are soft
Offshore drilling and production activity is bottoming out in 1H18. The average utilization rate of the facilities climbed back to 60%+ by Jun-18, shown in Figure 7 &8. However, day rates were still on the downtrend, and those operators subject to higher operating costs barely benefited from the market turnaround. We are encouraged that major oil players are reporting strong earnings since 4Q14, see Figure 9. But they were still cautious and prudent on the oil market outlook since the expected capex in 2018 is just slightly higher than that in 2016, shown in Figure 10.
Oil market is embracing higher volatilities
In the near term, we believe oil prices will fluctuate widely. On the one hand, the market will continue to price in geopolitical risks such as trade war tensions and output disputes. On the other hand, the proceeding of the Fed rate hike cycle and shrinkage of balance sheets in major central banks could slow the recovery of the global economy. Oil market is filled with much more noises moving forward.