(12 MAY 2017)DAILY MARKET BRIEF 1:Do not get carried away by oil’s dead cat bounce

(12 MAY 2017)DAILY MARKET BRIEF 1:Do not get carried away by oil’s dead cat bounce

12 May 2017, 13:47
Jiming Huang

After falling as much as 20% in the second half of April, crude oil is making a comeback as the West Texas Intermediate bounced back at around $48 a barrel, up roughly 3% over the week. After the decision of OPEC and its allies to cut supply back in November last year, investors entered into a wait-and-see mode and took their time to assess the effectiveness of the OPEC decision. The market’s enthusiasm was only short-lived but the WTI stabilised at between $48 and $55, during the first quarter at least.

It is quite clear that OPEC is always a trifle late. A few years ago the Cartel, realising that the US shale industry could jeopardise its dominant position in the oil business, tried to nip them in the bud by flooding the market with cheap oil. This move stopped any new investments in upstream exploration and killed the momentum of the US shale industry. However, the move came quite late as North America’s frackers were already too efficient and were able to lower their break-even price well below $50 a barrel.

The problem now, is that OPEC countries are struggling with cheap oil prices, even though their breakeven prices are much lower (around $20 a barrel for Saudi Arabia, for example), as they need a higher price to balance their state budgets. To lift prices, OPEC trimmed production last year and members are currently discussing to extend the cut. Unfortunately for OPEC and its allies, the US shale industry, which does not participate to the cut, is the primary beneficiary of those production cuts. Indeed, the higher the price, the higher the number of profitable US wells.

Against such a backdrop of supply glut and subdued demand, we believe that the recovery in oil prices is quite limited, especially given the current set-up. The cartel has to cut production more aggressively and for longer if it wants to lift prices substantially. Only in the latter case, may we see WTI above $55 a barrel, but again, the primary beneficiary will be the US shale industry.

By Arnaud Masset
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