If Opec members' compliance remains loose, oil may fall upto $42: Deshpande

Interview with Abhishek Deshpande, Chief Energy Analyst, Natixis Commodities

Last year's pact between members of Opec, the petro exporters' cartel, and non-members to cut crude oil production has faced several challenges. Abhishek Deshpande, chief energy analyst at London-based Natixis Global Commodities Markets Research, told Rajesh Bhayani oil prices might take longer to rise. Edited excerpts:

Is it Opec members’ breach of output quotas or shale oil supply increase that is pushing oil prices down?

Both. Shale production got revived due to US producers reducing costs and hedging 2017 production at elevated prices after the Opec and non-Opec deal. And, there is rising production from Opec members whose output was never capped, particularly Libya and Nigeria. With that excess oil, other Opec members’ compliance has also started to go down. Compliance fatigue is setting in — this is the worst of the worst scenario for Opec, with low oil prices and also lower export. Speculative investors are also treading carefully before getting into large positions in oil. 

Opec met on Monday and decided to tighten loose ends in the production cut agreement. How will that impact prices? Where do you see prices by the year-end for Brent and WTI (crude oils)?

Without caps and potentially cuts from Libya, Nigeria and Iran, and good levels of compliance from other Opec members, oil prices might take longer to rise. We expect in our central scenario for oil prices to average around $55 a barrel for Brent. But, if Nigeria and Libya continue to add oil, followed by Opec members’ compliance reducing even further, we will gravitate more towards our lower case scenario of a Brent average of $42 a barrel. 

How are financial investors playing market? 

They’d reduced their net longs by over 500 million barrels worth of Brent and WTI contracts between February and June. 

In July, however, there had been a small pick-up in net longs by  speculators, up by 120 mn barrels of contracts combined for Brent and WTI, though this is still nowhere close to the levels seen in February. If there was a sign of a sustained drawdown from a balanced market, we might see a surge in net longs, which could drive up prices quickly. For now, however, that risk remains limited, given that so much oil is still hitting the markets.

How will oil prices remaining under check affect the refining business and refined products' prices?

Refineries in general had great years in 2015 and 2016. In 2017, so far, they continue to enjoy healthy margins worldwide, due to robust demand and oil prices not rising so quickly. Equally, it is perhaps not as good as in previous years for some regions, due to pressure from excess products in storage at the beginning of the year. 

When prices were around $30, India and China built reserves. Do you see a repeat of that and if so, at what level will reserves’ building demand come in?

Strategic reserves remain key to India and China. This is dependent both on oil prices and available storage. China has built its phase-1 and phase-2 of strategic reserve capacities; it now has over 250 mn barrels in reserve. India is yet behind the curve but is rapidly building its own. 

Currently, the planned capacity to be built for India is around 110 mn barrels, of which 38 mn has been filled. Both India and China can import more crude to fill some of their strategic reserves but with prices remaining low, there might be less inclination in filling this up quickly, contrary to what one might think.