Crude Oil Outlook: Inventory fall crucial for trend reversal

From a high of $112 a barrel in August to lows of $92.86 a barrel in November on the Nymex, West Texas Intermediate (WTI) crude oil has witnessed sharp swings in fundamentals and prices during the year. From witnessing back-to-back gains for three months between June and August, to succumbing to negative supply-side fundamentals, the commodity has swung from gains to losses this year. Factors that supported oil prices higher were a host of supply disruptions across the West Asia and Africa, along with a sharp slump in oil inventories monitored by the EIA (Energy Information Administration) between May and August.

Between June and July this year, crude oil prices on the Nymex jumped 17 per cent, but on the MCX, gains were phenomenally higher with rise in prices to the tune of a whopping 37 per cent, as rupee depreciation supported sharper gains in prices on domestic bourses. But in the months of September and October, prices on the Nymex have slumped five per cent and six per cent, respectively.

During these two months collectively, inventories on the EIA were up by more than seven per cent, thus reversing the upside momentum in prices. Around 1.3 million barrels a day of crude oil refining capacity was taken offline, as refiners put plants under maintenance. Refinery utilisation rate declined more than six per cent, suggesting crude oil was put back into storage (leading to increase in inventories). Since refinery maintenance activity is ending now, we expect inventories to fall again, and this will bring back the buzz in crude oil, especially during the peak winter-demand season. By mid-November, around 700,000 barrels per day of refining capacity is expected to return.

However, a comfortable supply-side scenario in the US is also acting as a negative factor for WTI crude oil prices. Domestic production of crude oil in the US jumped to 7.98 million barrels a day on October 18, the highest since March 1989. Further increase in production is seen as the IEA (International Energy Agency) expects the US to become the largest oil producer by 2015, thus surpassing Russia and Saudi Arabia.

Until the crude oil inventory decline begins, oil prices are expected to remain under pressure. If inventories do not decline sharply then the commodity is likely to hit levels below $90 a barrel on the Nymex. But winter-season demand in the US is expected to act as a saviour and we could see a bit of support towards the end of November and during December this year, during which Nymex crude oil prices could test levels between $97-$99 a barrel and in the Indian markets, one could see oil testing Rs 6,200-6,350 a barrel, with Rs 6,400 a barrel acting as a crucial resistance point.

However, despite the winter season, sharp increase in Nymex crude oil prices above $100 a barrel in the short-term (two to three months) is not expected and even if prices cross this crucial mark, we do not expect the commodity to sustain above these levels as a comfortable supply scenario in the US is likely to keep a check on sharp rise in crude oil prices.

The spread between Brent and WTI is likely to widen over the short-term as supply-concerns will support rise in Brent prices whereas, WTI will witness downside pressure on account of high inventories coupled with a more than comfortable supply-side scenario in the US. Over a one month period, Brent crude oil prices are expected to test $112 a barrel and from a three-month perspective, we expect the commodity to rise further to $116-117 a barrel.

The author is associate director, commodities and currencies, Angel Broking