Weaker market fundamentals to be drag on oil prices: Samba

 By Pratap John/Chief Business Reporter

Weaker market fundamentals will eventually be a drag on oil prices this year with average Brent prices holding at around $107 per barrel this year and some slippage to $103/b expected in 2014, Samba Financial Group has said in a report.

Saudi-led Opec supply management will ensure the average Brent price holding this year, though Samba says it will not be surprised to see prices weakening in the spring, similar to last year.

There are many reasons for the oil market to likely weaken this year, the report said.  Mainly the expected gains in North American and Iraqi production, which should keep global supplies elevated at a time of modest demand growth. In addition, challenges remain in the global economy with budget spending cuts in the US, and political fragility in parts of Europe posing downside threats to demand.

Oil prices strengthened in the first two months of the year, bolstered by optimism that major tail risks to the global economy have receded, including the full US fiscal cliff, a potential hard landing in China and the break-up of the eurozone, some positive growth momentum, and a sharp drop in Saudi oil production. Geopolitical concerns have also continued to support a risk premium, while sustained quantitative easing from major central banks has pushed more money into the futures market, Samba said.

Although dated Brent hit a high of $119/b on February 14, it quickly dropped back to below $110/b in March. With little change in fundamentals over this period, the retrenchment is largely thought to reflect a less rosy reassessment by financial investors on future market fundamentals. Nonetheless, the average year-to-date price ($113/b on March 11) remains up slightly on the 2012 annual average.

While the oil market has been buoyed by the general improvement in global sentiment, prices did appear to be higher than justified by fundamentals given that global crude stocks are undergoing a contra-seasonal build, spare capacity is being rebuilt, and demand prospects remain relatively muted.

Although the outlook in China may have improved with Beijing continuing to fill strategic tanks, the IEA revised down its 2013 global demand forecast again in February. This is now projected at 90.76mn bpd, an increase of 840,000bpd, principally driven by Chinese and the Middle Eastern demand.

It is widely expected that non-Opec crude and NGL supply growth will cover most, if not all of this incremental increase, driven in large part by sustained gains in the US — where output rose 812,000bpd last year and now tops 7mn bpd — and Canada, and the likely return of Sudanese supply. Growing Opec NGL output and projected strong gains in Iraqi production, which could hit 3.7mn bpd this year, will also add to an apparently ample supply position.

“However, complicating any assessment of oil market prospects is the increasingly volatile supply outlook, which faces both downside and upside risks, although the short-term burden appears to be on the downside,” Samba said.

Geopolitical risks are especially elevated and now weigh on much of North African supply following the attack on a gas installation in Algeria, conflict in Mali, and sustained tensions in Libya.

Nigeria is also not immune, and political disagreements in Sudan may well delay the return of supply there. The sustained Syrian conflict, combined with internal strains, could also threaten the expected growth in Iraqi supply.

Meanwhile, tightening sanctions on Iran may squeeze supply there further, although there does now appear to be slightly more chance that a compromise can be reached on the nuclear impasse, Samba said.