After hitting a fresh 13-year low of $27.10 per barrel on January 20, front-month Brent crude futures – the global benchmark – have been on an amazing run higher of late.
Even with the decline witnessed overnight, the price has still rallied 46% in just 34 trading sessions.
An amazing rally in anyone’s language, fueled by short covering, weakness in the US dollar and constant speculation over the future actions of OPEC.
While the supply surplus in the market remains intact, something that along with weaker global growth and a sharply stronger US dollar contributed to the enormous rout of past years, Michael Hsueh, a commodities analyst at Deutsche Bank, believes that factor will diminish in significance in the years ahead, helping to underpin higher crude prices as a consequence.
The chart below, supplied by Deutsche, reveals the balance of the crude market since 2007, along with the bank’s forecasts for global supply and demand in the years ahead.
As it reveals, Deutsche expects the market surplus seen since 2014 will diminish in the years ahead, eventually turning to a deficit in the second half of 2017 based on modeled forecast.
“Our revised balance shows that the current year will remain in a material surplus of +650 kb/d, representing a halfway point between the +1,150 kb/d surplus last year and a modeled +160 kb/d surplus in 2017,” says Hsueh. “The overarching theme for the medium term remains that the surpluses we are now experiencing, however severe, appear to fade over the next several years.”
As a result of supply-demand imbalances improving, Hsueh suggests after a period of renewed weakness in the months ahead, the trajectory of the crude price will likely be higher, not lower, in his opinion.
“Therefore we hold to medium term expectations for oil prices to rise towards US breakevens of USD 50-55/bbl during 2017 given the lead times required between investment and production,” says Hsueh.
“Risks to this view are that trend demand growth slows, prolonging the surpluses to the extent that upstream companies are forced into successive rounds of cost deflation which then materially lower the incentive cost of new oil supply. To date, we note that the assessment of postponed, marginal projects suggests that incentive costs remain in the range of USD 55-64/bbl.”
Hsueh doesn’t offer an upside risk scenario in his forecasts, suggesting risks are slanted to the downside given higher prices run the risk of seeing previously uneconomic supply reentering the crude market.