Oil market fundamentals worsen, glut to persist for longer

Latest oil market reports from OPEC and the IEA make stark reading for those hoping that supply and demand would rebalance in 2017. Demand is falling and supply is rising, according to the groups, putting even more of an onus on OPEC members to act.

A global oil market supply glut caused oil prices to tumble in mid-2014, and the world remains awash with oil as OPEC output continues to rise and demand remains weak. Still, there had been hopes that a drop in non-OPEC supply, particularly in the US, combined with a pickup in demand driven by cheap oil prices, would help ease the situation in the second half of this year and lead to a re-balanced market in 2017. That had driven the oil price back to about $50 a barrel. Those hopes have apparently been dashed.

The International Energy Agency (IEA) has issued a stark warning that the market will remain in surplus in 2017, as a promising rise in demand in the first half of 2016 has completely evaporated. It says demand growth in the third quarter was the lowest in two years, which it blamed on a slowdown in many European countries as well as China and India. There may be a rebound in the fourth quarter, of course, as winter weather sets in the northern hemisphere, but the IEA is still cutting its oil demand forecast by about 200,000 barrels a day for the second half of 2016 and throughout 2017.

It’s report follows a warning from OPEC that supply from its non-OPEC rivals will rebound by 200,000 barrels a day in 2017, driven by the start-up of a major new oilfield in Kasakhstan. That was a flip from OPEC’s previous two reports which had predicted a drop in non-OPEC supply of 150,000 barrels a day next year. By OPEC’s estimates, oil stockpiles in developed countries remain 341 million barrels above their five-year average, although the group still thinksdemand will remain strong and help diminish the supply glut in coming months, conflicting with the IEA prediction.

The latest estimates and predictions on the global supply and demand situation come ahead of a gathering of OPEC and other producing nations in Algeria at the end of September. One of the reasons oil price have risen to near $50 a barrel in recent weeks is hopes the producers will agree a supply freeze at that meeting.

There are still major doubts about whether a deal can be done. The world’s largest producer, Saudi Arabia, is lukewarm about a freeze, while Iran and Iraq are still increasing output following wars and sanctions and they’re unlikely to support a deal until they’re pumping at full capacity.

As we’ve suggested before, even if a deal was done to freeze OPEC production at near record levels, it would still need a big drop in non-OPEC supply and further strong demand to re-balance the market during next year. The latest reports suggest a re-balancing is even further away, and an OPEC freeze would do little, if anything, to help ease the situation. Remember, crude stockpiles in the world’s biggest oil consumer, the US, are at their highest seasonal levels for more than 20 years.

Fundamentally, it’s going to take a supply shock in a major oil producer, or a renewed pickup in demand in major oil consuming countries like the US, China and India, to re-balance the market and give oil bulls renewed hope. However, it’s likely oil prices will continue to find support ahead of the gathering of oil producers in Algiers, but failure to reach a deal may lead to a capitulation and a renewed drop in prices.

From a technical perspective, we have seen fundamental announcements heavily influence Brent prices, leading to a pickup in volatility in recent weeks. However, while this is likely to continue, the argument above signifies that there is reason to believe we could see a turn lower soon. Recent price action has set us up for such a potential move lower, with a head and shoulders pattern forming.

With that in mind, an hourly close below $47.10 would provide a strong sell signal, leading to a bearish outlook. The height of this pattern means we would be looking for a projected target of $3.50 lower from the exit of the pattern, which coincides with the crucial $43.61 swing low from August.

Such targets are a rough approximation of potential distances for such a break down, yet irrespective of the size, a closed candle below $47.10 would certainly have significant bearish connotations, setting us up for some potential opportunities to the downside. Conversely, an hourly close back above $48.82 would negate this bearish outlook.

Find out more about what's driving the price of oil

The information on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG Bank S.A. accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it and as such is considered to be a marketing communication.