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Oil

Shale is the name of the game

The oil price rebounded 18% in January, closing the month at USD 53.8 per barrel (WTI). The XOP index of US shale oil & gas producers rose 15%, while our selection of stocks gained 13%. This slight lag versus the index is mainly attributable to our larger weighting of major Permian basin shale oil producers, which rebounded less than the smaller companies.

shaleOil VsWTISource : Bloomberg

The further collapse of Venezuelan oil output and OPEC/Russia production cuts are starting to show up in (US) oil inventories. The fact that these are not rising (as would normally be the case at this time of the year) is an indication that the market is no longer oversupplied. Looking out further in the year, the market might actually become tight should President Trump decide not to extend the Iranian waivers that expire in April and OPEC/Russia remain disciplined with respect to their production.

It is a public secret that Saudi Arabia has an oil price target of USD 80+ per barrel, in order to be able to reduce its budget deficit, so we can assume that they will not be increasing production until they reach that level.

The unexpected oil price crash during the last quarter of 2018 shook US shale oil producers seriously. Most have announced lower than previously planned budgets for drilling and fracking in 2019. They try to limit their budget expansion to the cash flow they can realise; as the oil price dropped, so did their budgets. In turn, this means that shale oil production growth will be (much) lower than earlier projected.

As for crude oil demand, it will increase in the second half of this year due to the IMO 2020 rule. Ships will no longer be allowed to use heavy fuel oil as of January 1st, 2020, meaning that refineries will need to increase their production to provide the market with the required low sulphur fuel oil and/or marine diesel oil. To do so, they will have to run at maximum capacity, needing more crude oil than usual.

The stage is thus set for a higher oil price in the coming months. The only risk to this positive scenario is the outcome of the US-China trade negotiations. If negative, the world economy and, in turn, demand for oil would be hurt.

(Update : 02.2019)

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