Oil: A lot of uncertainty on the market

At the beginning of July we have pointed that the declines on the oil market are probably just temporary and will lead to WTI testing $65 handle. Key technical levels have not been disturbed and prices have begun to increase once again. Nevertheless, we are encountering range trading that reflects the uncertainty concerning the future of the market.

The factor that has contributed the most to oil prices rising to the highest levels since 2014 is the Iranian case. Donald Trump decided to withdrew from the nuclear accord in May and has put a vast amount of Iranian oil supply and exports under threat. While Iran has risen its production by around a million barrels following signing of the agreement, Donald Trump tries to shrink profits of the country’s oil sector to zero. The relations between the US and Iran has been sluggish in the previous weeks. The United States kept reminding their allies to cease all the trading activity with Iran under the threat of imposing sanctions while Iran urged the US to change its decision. However, Trump expressed his interest in conducting negotiations aimed at working out a new agreement. Still, the Iranian side stayed reluctant towards changing its stance. Moreover, rumours have surfaced lately that the US may be considering military intervention in Iran. On the other hand, Iran is said to be regrouping its fleet near the Strait of Hormuz, a narrows crossed by over 20 million barrels each day (around a fifth of the global supply).

Any clear impact of Trump’s decision has not been spotted yet. However, a minor decline in the production figures looks worrying. Source: Bloomberg

Indeed, we can see a decline in the Iranian oil exports but it can be mainly attributed to the shrinking imports of the European countries. Imports from Europe will most likely continue to decrease. The biggest uncertainty concerns the performance of the exports to India and China. Source: Bloomberg

According to some reports, India was to decrease its imports in June (in comparison to May). Indeed, we can see a minor drop on the chart above but it is insignificant. In the second quarter of the year India imported an average of 715k barrels each day, marking a 45% increase against the first quarter. Assuming that China will not alter its policy India will continue to be a key player when it comes to the imports of the Iranian oil. Iran itself claims that other producers, like Russia or OPEC cartel, will not be able to offset the 2.5 mbd drop in supply (in case Iranian exports are diminished to zero). Is it so?

OPEC, mainly because of Saudi Arabia, has raised its production in the last month by around 300kbd, the second month of such an increase in a row. Source: Bloomberg

Russia has increased its oil production to almost the highest level in history reached before the production cut agreement was signed. Source: Bloomberg

Investment banks, like for example Barclays, suggest that in the aftermath of the US sanctions Iranian exports may shrink by as much as 700k bpd. Do notice that OPEC and Russia managed to increase its production by more than this in the past few months. Moreover, one needs to be aware of the constantly rising US production. What can go wrong?

Of course, much is dependant on the actions of the US and India. In case we see this countries continuing to pressure its allies and offer them concession for halting trading activities with Iran we will most likely see drop in the Iranian production and exports. It should be noted that the US exports are not far behind the Iranian one in terms of size. Moreover, the US has a lot of crude to export yet it lacks infrastructure to transfer it.

As we can see the United States are capable of exporting as much as 3 million barrels of oil per day. Moreover, the latest build in the oil inventories partially resulted from the drop in the export numbers. Source: Bloomberg, XTB Research

Last but not least, a quick look at the Baltic Dry Index may keep the heads of the oil bulls cool. Baltic Dry Index is a gauge reflecting the costs of the naval transport. Despite the rising concerns the index continues to advance reflecting the fact that the demand for such services is still strong (what may point at large trading volumes). Having said that, oil prices should not be impacted by fears of limiting transportation capacity for now. Combining all of the above mentioned factors we have decided to uphold our recommendation from July 16. We recommended going long on oil WTI with a limit order at $65-66 (50% retracement level of the major slump started in 2014) and targets at $75 and $80. We suggest placing a stop loss order at $60.40.

WTI has once again rebounded off the 50% Fibo level. Source: xStation5