The Commonwealth Bank thinks a big reversal in crude prices is coming

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Crude oil prices continued to march higher overnight, rising to the highest levels since December 2014.

Thanks to a combination of broad-based US dollar weakness, expectations for stronger global growth, ongoing production limits from OPEC and non-OPEC producers and signs that global crude markets are tightening, Brent crude — the global benchmark — now tops $70 a barrel, extending its rally from early 2016 to 161%.


Brent Crude Weekly Chart

Quite the recovery, right?

As Vivek Dhar, Mining and Energy Commodities Analyst at the Commonwealth Bank, points out, there’s any number of factors out there to explain why crude prices continue to rally.

“Oil prices [rose] to multi-year highs after US crude oil inventories fell by 1.07 million barrels (mmbbl) to 411.6mmbbl in the week ending 19 January, just above forecasts of a 1.00mmbbl decrease, he says, adding that “the drawdown marks a record 10th consecutive week of falls in US oil stockpiles.”

Pointing the chart below, Dhar says the fall in US inventories has led to optimism that oil markets are tightening.

Source: Commonwealth Bank

“That view certainly has merit, with US stockpiles below the 5-year average from 2013 to 2018 for this time of year,” he says. “Even OECD stockpiles are approaching the 5-year average.”

Dhar says a major influence behind the tightening in global oil markets is the OPEC-led deal amongst OPEC and other allied producers to sideline 1.8% of global supply until the end of 2018.

Coupled with strong compliance from crude producers to adhere to production limits and stronger global growth, its fuelling optimism that crude markets will continue to tighten, keeping prices elevated.

However, while others are clearly optimistic that will occur — one only has to look at the price action since the middle of last year for evidence — Dhar shares a significantly different view.

On the back of an expected reversal in US crude inventory levels and higher US crude production, he forecasts that Brent prices will fall sharply by the end of this year.

“Our bearish view on oil markets is driven by concern that supply growth could outpace demand this year,” he says.

“The US Energy Information Agency (EIA) forecast OECD stockpiles to expand by the end of the year [while] US supply is set to surge by around 10% this year as US shale producers respond to rising margins.”

Although Dhar is forecasting that demand will grow strongly again this year on the back of OECD consumption growth, he says “the larger risk at play though is that current oil prices may encourage more supply and discourage consumption”.

As such, he’s looking for the rally in crude prices to reverse in the months ahead.

“We expect Brent crude oil to fall to $53 a barrel by [the December quarter] as surplus concerns are revisited later this year.”

From its current level of $70.50 a barrel, that would represent a decline of 24%.