Oil price continues rally, but on weak fundamentals

Singapore

CRUDE oil prices continued its rally on Monday as Opec gave a brighter outlook for market fundamentals this year, but analysts warned that the boost in the market is likely to be temporary.

The drop in the rig count in the US - the main factor that propelled oil prices higher earlier last week - would result in a cutback in production only much later, they said, with some cautioning that the oil price could pull back in the weeks to come.

The international oil benchmark Brent crude on Monday was up 73 US cents at US$58.53 a barrel at 8pm Singapore time. The Nymex West Texas Intermediate was 17 US cents higher at US$52.86 a barrel.

The Organization of the Petroleum Exporting Countries (Opec) in its monthly report on Monday revised upwards the demand forecasts for its oil by 430,000 barrels to average 29.21 million barrels per day (bpd).

At the same time, capital expenditure cuts by international oil companies and the reduced number of active rigs in the US and Canada led the oil cartel to sharply lower the rate of growth in non-Opec supply to 850,000 bpd.

Prior to Opec's announcement, Brent crude rose more than 9 per cent last week, its largest rise in a week since February 2011. This came after news that the number of active rigs in the US had dropped by 94 for the week ended Jan 30 - the largest decline since oilfield services firm Baker Hughes started such data in 1987.

The fall in the number of rigs in service continued last week in its ninth straight decline, falling by 83 to 1,140, the lowest level since December 2011, in an indication that falling oil prices were starting to hurt US shale producers.

Last week's oil price bounce was not driven by market fundamentals but by changes in market sentiment and paper trading, analysts said. Rigs that have been idled so far were largely in the less productive wells, said Victor Shum, vice-president at consultancy IHS Energy, and as oil exploration firms continue to drill the best prospects, US oil production would still grow this year. "US production growth will likely only decline later this year and towards the end of the year, it will be close to zero on a month-on-month basis," he said.

Concurring, Phillip Futures analyst Daniel Ang said that US oil production remains strong for now, pointing to the 9.1 million barrels that it continues to pump out each day. This, coupled with poor demand from the major importers of China and Japan, means that crude prices are "still consolidating", he added.

In the near future, the abundance of oil supply and the continued buildup of crude oil inventory will push prices lower. Said Jeff Brown, president of oil and gas consultancy FGE: "We expect oil price to drop again in March or April, possibly below US$40 a barrel. This will be short-lived, however, and in H2 2015 (the) price will bounce back."

Analysts widely agree that the oil price will pick up in the second half of the year, when a reduction in oil supply will coincide with higher seasonal demand.

The hedges that US oil producers have entered into protecting them from lower oil prices would expire by then, exposing them to the full impact of the oil price slump, said OCBC economist Barnabas Gan.

Opec's June meeting could also be a contentious one, where smaller Opec members bearing the brunt of the lower oil price would likely push for a reduction in the cartel's production quota again, he added.

In the meantime, the oil market will continue to be whipsawed as uncertainty remains.

"We are likely to have multiple false rallies and continued high volatility as the market sorts out the effects of reduced drilling budgets," said Mr Shum.