Is $50 the new $100 for crude oil?

The near 80 per cent rebound in oil prices from their February lows has finally started to fizzle and we believe more corrections are on the cards in the near-term as some of the pillars of the price rally start to give away.

Investors were reluctant to buy at higher levels and prices could not sustain above $50 for much longer.

One of the biggest factors driving the recent rally was unexpected supply outages, which pushed around 2.5-3 million barrels per day (bpd) of crude oil out of the global market. Adding to that, the slowdown in US oil output and a weaker dollar exacerbated the price strength.

The oil market was oversupplied by nearly 1.8-2 million bpd until the end of Q1 but unexpected supply outages brought the market in balance over the past couple of months.

If it weren’t for the cushion provided by the record level of inventories globally, the extent of current outages (2.5-3 mbpd), would have pushed prices close to $100/barrel in a very short time in any other period. Pipeline attacks in Nigeria have cut output by nearly 1 million bpd and Nigeria’s total oil output is now near 0.8 mbpd compared to 2 mbpd a few months ago.

Prior to that, wildfires near the Alberta oil sands in Canada reduced nearly 1 million bpd of Canada’s oil production.

Adding to that, US crude oil production has dipped by nearly 0.5 mbpd so far in 2016 and is near 8.71 mbpd currently. US oil production is down almost 0.9 million bpd from its peak of 9.6 mbpd and US shale oil output is also expected to fall in July for the seventh consecutive month.

As per EIA data, total shale output is expected to fall to 4.72 million bpd in July from a peak of 5.5 mbpd in March 2015.

The interplay of these supply-related factors in the last two months led to the quick snapback of prices from their lows seen during the panic of February.

Looking ahead, we believe that oil prices have seen their top at least from the short- to medium-term perspective as some of the factors underpinning price strength have started to wane. Firstly, even as Nigeria’s output still remains affected due to repeated pipeline attacks, Canada’s output is on track to resume partially by end-June and to its normal level by the end of July.

Secondly, there is some evidence that US oil drillers are comfortable in re-starting drilling if prices stay around $50. Rig counts have increased in the last two weeks but we will still have to see if the trend has actually turned.

Thirdly, Iran’s oil production has resumed quickly in recent months and is likely to reach pre-sanctions levels in the next two to three months. Iran’s oil exports are on track to hit their highest level in four years in June as shipments to Europe recover to near pre-sanctions levels.

Therefore, we will see the impact of supply outages fade in the next couple of months which will act as a headwind for prices. Importantly, the global market sentiment also looks fragile at the current juncture with a Brexit vote looming large over financial markets. In the event of a Brexit, a risk-off sentiment could dent oil prices further.

The writer is Associate Director & Head, Motilal Oswal Commodities Ltd. Views are personal.