- Morgan Stanley is maintaining its 2018 oil forecasts, despite an 11% fall in prices over the last two weeks.
- Prices will be supported by a global supply shortage of 200-300,000 barrels per day.
- The supply/demand backdrop will also drive increased activity in oil futures markets, which should help to support prices.
Morgan Stanley (MS) analysts Martijn Rats and Amy Sergeant are sticking with their 2018 oil price forecasts, despite last week’s sharp declines.
After hitting a multi-year high of $US71 a barrel at the end of January, prices for benchmark crude oil closed overnight at $US63.08 — a fall of more than 11%.
But the MS duo maintain their belief that prices will return to $US75 a barrel by the September quarter.
They said the global oil market will remain undersupplied by around 200-300,000 barrels per day in 2018.
That in turn will drive technical price action in oil futures markets that will also be supportive of prices.
“Global inventories, expressed in days-of-demand cover, were already well below the five year average in November, and close to the bottom of the historical range,” they said.
Furthermore, “preliminary data from the International Energy Agency suggests another drop in inventories in December, at least for OECD countries, of 43 million barrels”.
And as shown in the chart below, the pair forecast that global demand will force an inventory draw-down in both the June and September quarters:
They also noted that although US oil production accelerated rapidly at the end of last year, it hasn’t resulted in a buildup of oil inventories.
“In fact, inventories drew sharply, indicating that demand for these barrels – be it from the US or abroad – was strong enough to absorb this supply.”
The backdrop of global undersupply gives rise to a structure in oil futures markets known as “backwardation”.
Backwardation is when longer-dated futures contracts trade at a lower price than shorter-date contracts. Here are the MS analysts on how that applies to the oil market:
“At the moment, the 12th month oil future (i.e. the March 2019 contract) trades at around $US59.4 a barrel whilst the front month future (March 2018) trades at around $US62.8 a barrel.”
It means that if investors purchase the cheaper March 2019 contracts and simultaneously sell March 2018 contracts, they could generate a return of 5.7% based on the difference in prices.
In such a scenario, the analysts said the investment return from trading oil futures offers a significant premium over 1-year US treasuries, which should attract demand.
The chart below shows how that premium has historically correlated closely with oil prices. More recently though, the relationship has broken down:
Rats and Sergeant said the breakdown could be partly attributed to the chaos on global stock markets last week.
“When other financial markets sell off strongly, their future returns improve. Most likely, this will drive funds out of oil futures, and into other markets. We suspect that this is what happened over the last two weeks,” they said.
Despite that, the analysts concluded that the global supply/demand backdrop in oil markets should continue to provide an attractive opportunity for investors in oil futures.