If Opec members refuse to cut output, oil may fall to $42: Natixis analyst

In a Q&A, Abhishek Deshpande also explains why India and China won't jump in to build their reserves

Last year's historic pact between the Organisation of the Petroleum Exporting Countries (Opec) and non-Opec members to cut crude oil production has faced several challenges, including non-compliance by some members, while shale oil producers sold futures at higher prices in the forward market. Opec is trying hard to ensure compliance from all nations. However, Abhishek Deshpande, chief energy analyst, London-based Natixis Global Commodities Markets Research, said in an interview with Rajesh Bhayani that oil prices might take much longer to rise. Edited excerpts:

What is pushing oil prices down? is it defiance on the part of some Opec members to heed the call to curtail production or is it the increase in the supply of shale oil?

It is both. On the one hand, shale production got revived with producers in the United States reducing costs and hedging 2017 production at elevated prices after the Opec-non-Opec deal. But, some Opec members, particularly Libya and Nigeria, has also ramped up production, as their output was never capped. With that excess oil to reconcile with, other Opec members have also started to become noncompliant. The compliance fatigue that is setting in is the worst scenario Opec had expected with low oil prices and lower exports. Speculative investors are also treading carefully this time before taking large positions on oil.

Opec met again on Monday and decided to tighten the loose ends. How will this impact prices? Where do you see prices by the year end for Brent and WTI (West Texas Intermediate)?

Without caps and potential cuts from Libya, Nigeria and Iran, and compliance of other Opec members, oil prices might take longer to rise. We expect in our central scenario, oil prices to average around $55 per barrel (bbl) for Brent. But, if Nigeria and Libya continue to add oil and if other Opec members' follow suit, then we will gravitate more towards our lower case scenario of Brent averaging at $42/bbl.

How are financial investors playing the market?

Financial investors had reduced their net longs (when an investor has more long positions than short positions) by over 500 million bbl of Brent and WTI contracts between February and June. However, recently in July, there has been a small pick-up in net longs by speculators, up by 120 million bbl contracts combined for Brent and WTI. This is still nowhere close to the levels seen in February 2017. If there is a sign of sustained draw-downs from balanced markets then we might see a surge in net longs, which could drive up prices quickly. But for now, the risk remains limited with so much oil still hitting the markets.

How have prices of refined products been affected?

Refineries, in general, had two great years — 2015 and 2016. As far as 2017 is concerned refiners still continue to enjoy healthy margins so far. Robust demand and no quick rise in oil prices are keeping margins healthy for most refiners worldwide. However, for some, it is not as good as previous years due to pressure on product cracks from excess products in storages in some regions at the beginning of the year.

When prices were around $30, India and China built reserves. Do you see this repeating? If yes, at what levels can the demand for oil to build reserves come in?

Strategic petroleum reserves (SPRs) remain key to India and China. Reserves are dependent on oil prices as well as on available storage capacity. China has built phase-1 and phase-2 of its SPRs with a capacity of over 250 million bbl. India is behind the curve but is rapidly building it. Currently, the planned capacity for India stands at around 110 million bbl, of which approximately 38 million bbl has been filled. Both India and China can import more crude to fill some of their SPRs but with oil remaining low, they may be less inclined to do it in a hurry, contrary to what one might think.