Hsueh On Oil:Brent breaks out

Putting prices in context.

    Brent prices have broken out above the USD 65/bbl equilibrium level. With ourmarket model balanced (neutral) in 2018 and 2019, any sustained move aboveequilibrium price would appear premature. Additionally, we believe that pricesremaining at USD 68/bbl (WTI 62/bbl) for a significant period (6 months to 1 year)could begin to change the supply outlook and meaningfully dampen the modeleddeficit of -754 kb/d we expect in 2020. In the absence of a demand surprisethis year, we see prices eventually moving lower before recovering on a moresustainable basis over the medium term.

    Identifying bullish drivers.

    We do not find the fundamental drivers particularly compelling at first glance,but the first suspect is a carryover effect from December pipeline outages inLibya, the North Sea, and Canada. Even severe outages such as Forties (417 kb/d) have a limited effect on the 2018 model because of their short duration (3weeks). However we allow that concerns over the possibility of a longer outage atForties could be helping Brent prices. A second factor is the larger-than-expecteddecline in US crude oil inventory in December. Key drivers behind this are astrong recovery in refinery utilisation to 96.7% and 8-wk average demand growthpeaking at +463 kb/d yoy on 20 December. However, one might have expectedUS strength to also be accompanied by a narrowing of the WTI-Brent differential.

    Since this has not occurred, it casts doubt on the US inventory story as a majordriver of the rally. Yet more difficult to ascertain is what increased risk premium,if any, the market may attach to political protests in Iran.

    Fundamental framework upended.

    The lack of clear fundamental drivers raises questions about the typicalcommodity cycle framework and may mean that other factors such as USDweakness since mid-December may also be playing a role. The typical frameworkwould hold that prices move above the mid-cycle equilibrium price only in theevent of meaningful supply-demand deficits. As evidence, we point to the lastdecade. Between 2006 and 2013, the market averaged a -500 kb/d deficit, andBrent prices averaged USD 89/bbl. From 2014-2016, the market averaged a +1.1mmb/d surplus, and Brent prices retreated from USD 99/bbl in 2014 to an averageof USD 49/bbl in 2015-16. Over the 2017-2019 period we expect an average of a+95 kb/d surplus