Oil prices showed a gradual recovery from January, and a continued rise was expected. Instead, Brent futures fell 18% in July, and are now down by 27% since the beginning of May. The downturn is the result of a string of news indicating that the crude oversupply is likely to persist.
It is expected that last month’s nuclear deal with Iran could bring additional barrels to the market as sanctions are lifted. Iran’s oil exports dropped from 2.6 mbd in 2011 to 1.3 mbd in 2013 as a result of the embargo. Iran’s oil minister stated that production will be increased by 0.5 mbd immediately after the sanctions are lifted, and the future potential is large. A large increase in Iranian supply would add downward pressure to oil markets which are already oversupplied.
Output from OPEC is accelerating in an attempt to retain market share. OPEC produced around 32 million barrels per day of oil in July as output from Saudi Arabia and Iraq reached new records.
Despite the low prices, US oil output has proved resilient. After a huge drop in the number of drilling rigs employed since last autumn, the rig count is increasing again. Also, Russian crude oil production is record post-Soviet high, rising to 10.7 mbd in June.
Concerns over the Chinese economy have also pressured the market. The Chinese stock market entered a free fall in July, with losses rising up to 32% compared to June. At the same time, a manufacturing index below 50 indicates contraction. Expectations of economic and oil demand growth are being revised down.
The bearish outlook has driven long term futures significantly lower. Crude remains in contango, but the forward curve has shifted lower. The 5-yr Brent future is down to below $70, a drop of around $10 over the past month.
Fundamentals are tightening
In spite of the negative sentiment, oil market fundamentals are tightening. According to EIA data, the excess supply shrinked from 3 mbd in May to below 1.9 mbd in June, due to a jump in demand and a slowdown in supply growth. The market is expected to continue to tighten during the last quarter of the year. The supply outlook is, however, uncertain.
We still expect a gradual recovery in prices, but the upturn has been delayed by recent market events.