Commodity rally won't last as fundamentals unchanged: analysts

Singapore

Oil prices clung to the US$40 threshold on Wednesday, cheered by a possible agreement between the world's largest oil producers to freeze output, even as analysts warned that the commodity rally in recent weeks is not sustainable.

Supply and demand fundamentals in commodity markets have remained largely unchanged, they said, and a full recovery in the oil market would probably take place only in the second half of this year or next.

The world's largest oil exporters within and outside Opec (Organization of the Petroleum Exporting Countries) are planning to meet in Moscow on March 20 to discuss a possible output freeze, Reuters reported.

Iraqi Deputy Oil Minister Fayadh al-Nema reportedly told state newspaper Al-Sabah that the country was "prepared to cooperate to discuss a plan to freeze production levels with the most prominent oil producers in the world and to guarantee that Russia and Saudi Arabia, the biggest oil producers and exporters, will sit at the negotiating table".

Hopes that a coordinated freeze would occur had been dented after Kuwait said on Tuesday that it would freeze production only if all major producers participate, including Iran which has been eager to boost its output to pre-sanction levels.

News of such talks between Saudi Arabia and non-Opec exporter Russia to fix supply at January's levels has catalysed the change in sentiment in the oil market since mid-February, with Brent having risen some 30 per cent since then.

Brent crude futures rose 4.2 per cent from its previous close to trade at US$40.39 at 9pm Singapore time. The US West Texas Intermediate benchmark traded at US$37.05, up 3.15 per cent.

The optimism in the oil market also boosted oil exploration firms and offshore and marine (O&M) players on the Singapore Exchange, with Ezra, Nam Cheong, Ezion, Interra Resources and Loyz Energy among the most traded stocks, gaining between 8 and 20 per cent on Wednesday.

Citigroup is sceptical about the impact of the proposed talks on actual production. "Talk is cheap and talking about talks is even cheaper," its analysts including Edward Morse - who had predicted the oil price plunge in 2008 - noted.

Even if a deal is reached, production would be frozen at a high level, said macroeconomic research firm Capital Economics. This, it pointed out, does "not signal the outright cuts in supply that would be required to rebalance the market quickly".

The expectation among analysts is that the rally in the oil price - which has taken place without significant changes in market fundamentals - would run out of steam soon.

Crude oil prices have gone as high as they can go, according to Phillip Futures analyst Daniel Ang.

He said that the release of US crude oil stockpiles data on Wednesday night could drive further momentum in the rally, but "even if this happens, we highly doubt that prices could go up much further".

The rebound in oil prices is largely driven by market sentiment and a change in speculative positions, as the recovery has caught out those betting on a fall to US$20 a barrel or lower, compelling them to buy back oil to cover their short positions, said Capital Economics analysts Julian Jessop and Tom Pugh.

"We would, therefore, not be surprised to see prices drop back in the coming weeks - before a stronger recovery takes hold," they wrote in a note on Monday.

Oil fundamentals are still weak, despite a slight improvement in the oversupply situation, added Mr Ang.

Concurring, CIMB analyst Lim Siew Khee said that there was still a global oversupply of about two million barrels a day, US historical stocks remain at a historical high and Iran could add another one million barrels a day into the market.

Warning that the recent frenzy in the Singapore O&M sector shows that the market is "trading on blind faith", she pointed out that default issues from Brazil are being ignored, and that investors are oblivious to the "crippled utilisation charter rates and glaringly-high leverage".

Crude oil production in the US fell by about 80,000 barrels a day from January levels to 9.1 million barrels a day in February, according to the US Energy Information Administration.

In its monthly Short-Term Energy Outlook report released on Tuesday, the agency reduced its previous forecast of next year's production from 8.46 million to 8.19 million barrels a day. It estimates that the US will produce 8.67 million barrels a day this year.

On the demand side, data released on Tuesday showed that China's exports fell by a more-than-expected 25 per cent last month - its biggest drop since May 25, triggering fresh worries over the world's second-largest economy.

While its crude oil imports jumped 19 per cent per cent month-on-month to 31.8 million tonnes in February, or eight million barrels a day, this is not expected to last as the refinery maintenance season approaches, and storage capacity reaches its limits, said analysts.

Higher oil prices will not be sustainable in the current environment, warned Goldman Sachs head of commodities Jeffery Currie on Tuesday.

"An early rally in oil prices would prove self-defeating," he noted, reversing the supply cuts expected to rebalance the market in the second half of this year. "Energy needs lower prices to maintain financial stress to finish the rebalancing process."

The investment bank expects a "trendless" oil market in the near term, with substantial volatility between US$40 a barrel, a level where oil producers will experience financial stress, and US$20 a barrel, which creates operational stress.

The surge in oil prices has been accompanied by a similar rally in industrial commodities. Iron ore on Monday recorded its biggest-ever one-day jump of 20 per cent, while copper, aluminium and zinc have rsen by between 10-25 per cent since January.

Societe Generale analyst Robin Bhar said that there are still "significant" headwinds in the coming year for these commodities.

Chinese demand remains weak on a bearish outlook for its construction, infrastructure and manufacturing sectors, while supply cuts to ease the glut have been delayed by sharp decline in production costs, he added.