
Kjus bucks oil consensus by calling for $70 by year’s end
Opec is going to do 'whatever it takes' to push the oil market into backwardation, DNB says
Oil prices will reach about $70 per barrel by the fourth quarter of this year, predicts DNB’s oil expert.
Such a price would mean a 44% jump in a matter of months, as Brent was at $48.47 per barrel and West Texas Intermediate (WTI) at $46.26 this week.
Even $60 per barrel would ratchet up expectations for offshore support vessels (OSVs) but, as the single-most important driver for the sector, oil prices at $70 could radically redraw the landscape for crisis-stricken shipowners.
DNB Markets senior oil analyst Torbjorn Kjus says the signs are already in the market to support his prediction, while Opec’s motivation also is now sky-high to keep to its agreed production cuts.
The market consensus is generally for the oil price to remain between $50 and $60 for the rest of this year.
“I step further away from consensus the more secure I am on the direction,” Kjus said. “I’m very certain about the direction and the rest of this year is going to be higher. We’re going to have meaningfully higher prices in the second half of this year so I put a price target of $70 for the fourth quarter.”
The DNB analyst says he is dismayed by how the “narrative” seems to have taken hold in the media that Opec’s agreed cuts will not work.
“The key misunderstanding in the market right now is that a lot of people seem to think that the Opec deal will break apart," Kjus said. "Several of the Wall Street banks, for example, predict that by the end of the year, the whole Opec deal falls apart. It’s not going to happen. They’re going to do whatever it takes to get the inventories down to the five-year average.”
Opec’s planned production cuts have seen varied success in the past, normally taking six to nine months to get only 60% to 80% compliance from members.
This time, the cuts are smaller than previously sought and compliance is already at 97% for the 11 Opec countries involved in the deal, if the International Energy Agency (IEA) numbers for October to April are used, he says.
One key motivation for Opec to keep to its cuts is the huge financial strain that the low oil price has on members’ national economies. For Saudi Arabia alone, the country has drawn down about one-third of its foreign reserves in less than three years. This means $731bn is down to about $493bn, amid cutting projects and costs such as public salaries, Kjus says.
“They have burned more than $8bn per month, so far this year, so the financial stress in Saudi Arabia is immense,” he said.
According to the International Monetary Fund (IMF), Kjus says Saudi Arabia’s fiscal break-even for 2017 is up around $80 per barrel.
“So they’re still burning through their [cash and foreign] reserves,” he said. “That’s the number one reason why Saudi Arabia needs to cut production because it’s quite an easy calculation. When you look at 2017 and 2018, if you cut production by 10%, the price goes up more than 10%.”
When the oil price moved up from $51 to $55 in the first quarter, it brought in an extra $4bn for Saudi Arabia over the fourth quarter of last year.
“They are going to bring in more revenues if they protect the price for 2017 and 2018," Kjus said. "They can’t afford to think very long term now. You have to put out the fire around you first. And, of course, the key issue here is that Opec is back to market management and a lot of people haven’t realised that yet. It’s not like they are going to leave that strategy in 2018.”
Kjus says, in terms of production, it is difficult to trust the numbers and there is not a lot of real-time data, with several months of lag time on inventory reporting. But he adds that the market is not “short of symptoms” to show that production cuts are working, such as a tightening in Brent spreads and in light/heavy oil spreads.
“All the production and exports that was counted in November and December has really hit the market in January and Febuary," he said. "It shouldn’t be surprising. It’s a two-month sailing time from the Persian Gulf to the US. So there’s a lag time here that many players seem to have missed. But, when we look at the latest numbers, there’s a big drop reported in exports."
Kjus also points to strong upward revisions in oil demand, which initially had looked weak for the US and India in the first quarter, again because of the time lag in the numbers.
Despite production growth in Canada, Brazil, Russia, Iraq and Iran, and also contrary to what many believe, Kjus says overall global production did not grow last year as more than 60 countries are listed with falling production.
When rising demand, falling production and Opec cuts are combined, it means the world is drawing down extra oil stocks and heading towards the five-year average on inventories. But he says this is heading towards an imbalance in the second half.
If inventories are low enough, it will encourage oil purchases and flip the market into backwardation, which is when futures are trading below expected spot prices. Kjus believes this will happen in the fourth quarter, which has occurred only five times since 1995.
“The interesting thing with backwardation is that every time it happens, the oil price has gone up,” he said. “If you get to a backwardation structure and keep it there, which is Saudi Arabia’s target basically, you will have a higher price.”
Contango structures, the opposite of backwardation, have occurred 17 times in the oil market in the past 22 years and prices have risen about half the time in those cases.