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What Is Keeping Oil From Breaking $70?

Posted on 05/01/2018

The protests in Iran have helped push oil prices up to fresh multi-year highs this week, but a lot of questions remain about the durability of the oil price rally.

Repeated and ongoing protests in various cities around Iran has raised questions about a possible disruption of supply, which, to be sure, remains highly unlikely. But the needling from the U.S. President’s Twitter account added fuel to that fire, helping to keep the price rally going.

The war of words probably makes it even more likely that Trump will take a rather dramatic move in less than two weeks when he faces the latest deadline over deciding on Iranian sanctions. Every three months, the U.S. President must waive sanctions on Iran related to the 2015 nuclear agreement (authority given to him per U.S. law, not the international agreement).

Trump decertified the nuclear deal in October, but it was only a partial move given that he declined to re-impose sanctions. We are now nearly three months on from that decision, and most analysts expect Trump, egged on by the unrest in Iran, to take that fateful step of bringing back sanctions.
Related: Is A “Geopolitical Recession” Looming?

That will certainly lead to more tension between the two countries, but it is highly unclear how this ends. As Liam Denning writes in Bloomberg Gadfly, Iran could be one of the biggest wildcards for the oil market in 2018. A serious disruption of Iran’s 3.8 million barrels of daily oil production remains remote, but not impossible.

That tail risk is likely driving the recent increases in oil prices, pushing WTI well into $60-per-barrel territory and Brent near $70, an unthinkable proposition until only recently.

Nevertheless, there are still some pitfalls to the current oil price rally, not the least of which is a massive buildup in bullish bets on oil futures from hedge funds and other money managers. Bets on rising oil prices hit a record high at the end of 2017, and the optimism likely carried into the first week of the year. At the same time, short bets fell to a nine-month low, according to Bloomberg.

But with so many investors piling into one side of this equation, the positioning is starting to look overstretched, particularly with the recent run up in prices. U.S. shale production is still growing at an impressive rate – and the EIA just reported a 170,000-bpd increase for U.S. oil production for the month of October, indicating a strong shale response to higher oil prices.

Most analysts see inventories rising in the first half of 2018, which, to be sure, is typical for the time of year, but would still delay the effort to take inventories down to the five-year average. The inventory surplus could very well disappear at some point in the second half of the year, but that is quite a ways away.

In other words, investors are bidding up prices even as the underlying fundamentals point to questions regarding the balancing process. Oil might push higher as inventories fall, but in the near-term there is downside risk to prices. Moody’s Investors Service said on January 2 that oil prices will probably bounce around in a range between $40 and $60 per barrel for much of this year.

The risk is that with so much money currently going long, a bit of negative news sparks a sudden selloff. “The expectation is that the rebalance will continue,” Gene McGillian, a market research manager at Tradition Energy, told Bloomberg. “We’ve approached an area where we really need to see a steady diet of positive information.”

Trump could yet provide that bump to oil prices if he steps up confrontation with Iran. “Beyond the recent focus on street protests, the potential reinstatement of US sanctions targeting the Iranian oil industry remains an issue,” JBC analysts said, according to the FT.

But it is always a gamble trying to predict what Trump will do.

By Nick Cunningham of Oilprice.com

Source: https://oilprice.com/Energy/Oil-Prices/What-Is-Keeping-Oil-From-Breaking-70.html

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