Physical oil traders not convinced by upbeat futures market outlook

[SINGAPORE] Tension is brewing in the oil market as the optimism of financial players who have poured cash into crude futures is not shared by physical players who keep cutting sale prices in a tough fight to secure customers amid an ongoing supply glut.

Money managers have amassed large bullish positions in US West Texas Intermediate (WTI) and international Brent crude oil futures after producer plans to cut output for the first time in eight years drove prices above US$50 a barrel.

"The oil market is irrevocably gravitating towards equilibrium, leading to higher prices," said Hans van Cleef, senior energy economist at Dutch bank ABN Amro in a note to clients this week.

Yet those who produce, refine or ship oil are less optimistic.

"One of the features of the market at the moment is probably physical crude is a bit longer than the paper markets are telling us," Ian Taylor, chief executive of commodity trading giant Vitol, told Reuters.

Consequently, crude futures are trading at premiums to their underlying physical grades. Brent futures are currently at a premium of about US$2 a barrel to Dated Brent crude cargoes in the North Sea.

And in a further sign of a well-supplied market, Middle East crudes from the United Arab Emirates and Qatar last month traded in the spot market at discounts of as low as 25 cents a barrel to their official selling prices.

Also, market data shows that just as financial traders have amassed long positions, producers have built up large short positions in the crude futures market, which would profit from falling prices, in what traders describe as a classic move to hedge themselves from a potential fall in physical oil prices.

Financial investors are undeterred by these cautious tones. Their optimism is driven by the Organization of the Petroleum Exporting Countries' (Opec) plan to cut production from record highs to rein in two years of oversupply.

Other indicators also favour financial investment into crude futures including a collapse in the gold to oil ratio.

The ratio between these two key commodities has plunged from 40 to below 25, and the head of oil research at Japan's Nomura bank, Gordon Kwan, said this implied either higher oil or lower gold going forward.

"One reason the gold/oil ratio spikes around periods of financial crisis is because oil prices tend to fall when economic growth is weak and investors are worried, while gold thrives in that environment," he added. "Assuming gold stabilises at US$1,250, if the gold/oil ratio hits 20x, this implies oil price could rise above $60 per barrel, consistent with our 2017 Brent crude average forecast," Mr Kwan said.

Morgan Stanley said this week that it expected Brent prices to rise from an average of US$42 per barrel this year to US$51 in 2017 and to US$70 on average for 2018.

But, while the focus is on Opec's cut, with Russia possibly joining, others warn output is creeping up elsewhere.

Eikon data shows that the amount of US rigs drilling for new production has steadily increased since May.

"Productivity has surprised on the upside... and with the rig count slowly climbing upwards one can be cautiously optimistic that the US shale industry is gearing up for a recovery," Ted Young, chief financial officer of Dorian LPG, one of the world's biggest shippers of liquefied petroleum gas (LPG), told Reuters.

Eikon data shows that global oil production has outpaced consumption since at least early 2015, with the current mismatch at about half a million barrels every day.

Jeffrey Halley, senior analyst at brokerage OANDA warned that while the financial market was becoming more confident,"the reality is the world is pumping a lot more oil then it uses."

Some in the financial markets are taking notice.

Goldman Sachs wrote to clients this week that despite a production cut becoming a "greater possibility", markets were unlikely to rebalance in 2017, warning of another price fall to the low US$40s per barrel. That would be a repeat of 2015 when financial markets pushed up prices just to slump back amid the ongoing glut.

REUTERS