Vol. 2 Issue 5 03 February 2017

BULLS BUILD RECORD LONGS ON NYMEX AS OPEC DELIVERS ON CUTS

OPEC has scored high on complying with its pledged production cuts in January, the first month of implementing its November 30 agreement, and the momentum should carry through to the remainder of the term, till end-June. OPEC’s own report-card for January, which will have members’ monthly production data as reported by half a dozen independent news agencies and industry organisations, will be out only on February 13. The OPEC/non-OPEC monitoring committee will not be meeting until March 17. But the market has homed in on news agency reports variously pointing to an output cut of between 840,000 b/d and 1.07 million b/d in January, or a consensus of around 940,000 b/d, equating to a 78% compliance with the agreed 1.2 million b/d reduction.

OPEC’s largest producer Saudi Arabia has made a bold statement by going beyond its promised 486,000 b/d cut and dropping its output below the 10 million b/d mark, levels not seen for nearly two years. This week, Saudi Aramco jacked up its official crude selling prices (OSPs) for March-loading barrels to customers across the world, with those in Asia seeing the largest of hikes, especially on the lighter grades. The fierce battle for market share unleashed by the price slump that gripped the market in mid-2014, especially in the coveted Asian region, looks to be in OPEC’s rear view.

Though data on all the 11 non-OPEC members who pledged a collective 558,000 b/d cut is a sketchy, Russia, the de facto leader of this camp, said it pared back by 100,000 b/d in January, which suggests a more accelerated pace to complying with its 300,000 b/d target than originally indicated in official comments, which had meticulously laid the ground for a “gradual” reduction. The bullish sentiment from the supply cuts could continue playing tug-of-war with any bearish stocks data in the coming weeks, but should ultimately overshadow it. A high degree of adherence with the roughly 1.8 million b/d of OPEC/non-OPEC cuts should eventually

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❖ OPEC members have slashed output by close to a million barrels per day, reaching nearly 80% of their pledged cuts. Non-OPEC Russia is also playing ball. The case for compliance to hold or even improve is strong.

❖ Bullish bets on NYMEX crude futures have risen to the highest in 10 years. Speculative length at the end of January surpassed the last peak in June 2014. This doesn’t mean prices are poised for a slump but promises volatility.

❖ Erupting tensions between Iran and the US: We expect continued sabre-rattling and even knee-jerk upticks in crude, but hard to see the nuclear deal or Iran’s post-sanctions increment in output being threatened.

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Vol. 2 Issue 5 03 February 2017

align with inventories being drawn down in the US and elsewhere in the OECD, lending another sentimental upward push to crude prices.

So will we see Brent, which has been trading in a tight range around $55/barrel for the past two months, spiralling up towards $60? We don’t think so, because somewhere between these two points, crude production in the US — where the number of oil rigs has jumped 72% since end-June 2016 — could start climbing significantly enough to cap the price rally.

The greenback, meanwhile, has been highly volatile since the start of the year, and has skidded nearly 4% from its 14-year highs notched at the start of January. Despite all the confusion and chaos unleashed by the Donald Trump administration in its first two weeks, swinging US stocks and the dollar between euphoria and anguish, the market expects the US Federal Reserve to stay the course with two to three interest rate hikes in 2017, likely in the second half of the year. That points to the dollar ending the year on a stronger note, possibly revisiting levels seen at the start of January, which would pressure crude prices down, though the impact could be blunted by the OPEC/non-OPEC cuts, assuming strong compliance.

We predicted strong overall OPEC and Russian compliance with their cuts and expect the total reduction to continue rising toward the 1.8 million b/d target. A combination of the Saudis going the extra mile and crude sustaining a more than 20% premium since OPEC

struck its deal creates a strong incentive for all the other producers to deliver on their commitments. However, we see a cap around $60 placed by a possible spurt in US crude production, which is highly responsive to prices.

BETTING BIG ON OIL PRICES

Hedge funds and other speculators have raised bullish bets on NYMEX crude futures to record highs, unsurpassed since June 2006, which is how far back the US Commodities and Futures Trading Commission data goes. These “non-commercial” traders of crude futures contracts, categorised as “ m a n a g e d m o n e y ” a n d “ o t h e r reportables” in the CFTC’s weekly Commitments of Traders report, are net long in the futures market at any given time. But the extent to which they increase their net length is an indicator of rising bets on strengthening prices.

© Vanda Insights �2

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Source: CFTC Commitments of Traders report

Vol. 2 Issue 5 03 February 2017

The speculators had accumulated a net length of 482,523 contracts, equivalent to about 482.5 million barrels, in the week to January 24, according to the latest CFTC data. The last peak of speculative net longs in NYMEX crude futures was about 459 million barrels, recorded in the week to June 24, 2014, when WTI was above $106 and poised for an epic tailspin.

This doesn’t mean that history is about to repeat itself. But it is an indicator of how much the market bulls have leveraged on the OPEC and non-OPEC producers delivering on their promised cuts. A bloated speculative length makes prices more vulnerable to volatile swings.

The COT data also shows a sharp spike in the net short positions of swap dealers starting mid-November, as anticipation of the OPEC production deal coming through at the group’s November 30 meeting gathered force, launch ing WTI toward the $50/barre l psychological mark. Swap dealers typically serve as counter-parties to oil producers looking to hedge their physical position.

Speculators have acquired record high net length on NYMEX crude futures, bet t ing on OPEC and non-OPEC producers delivering on their promise to cut output by a collective 1.8 million b/d.

Nervous longs rushing for the exit door at the slightest signs of supply not being mopped up to the extent expected will spur price volatility.

© Vanda Insights �3

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Source (all graphs on this page): CFTC Commitments of Traders report

Vol. 2 Issue 5 03 February 2017

IRAN - NOT THE NUCLEAR OPTION

After putting Iran “on notice” for test-firing a ballistic missile January 29, the Trump administration was preparing to levy additional sanctions on the Islamic Republic as the week came to a close. The warning from the White House on Wednesday provoked a knee-jerk reaction in crude, boosting WTI and Brent futures by more than a dollar as it raised the spectre of a range of bullish outcomes, from Iran losing its post-sanctions boost in crude production to a rattled Tehran threatening Middle Eastern oil flows through the vital Straits of Hormuz.

The market calmed down subsequently, as it became evident that the US was not threatening the nuclear deal signed by the world powers with Iran in July 2015.

The US is contemplating fresh sanctions against Iranian individuals and entities, which entails asset freezes, travel bans and other penalties, but has said these won’t violate the nuclear deal. The war of words between the two countries could escalate in the coming weeks, but we don't see a threat on the horizon to Iranian crude production or oil shipments through the Straits.

To put fundamentals into perspective, the joint OPECnon-OPEC cuts are effectively creating a spare capacity of

at least 1.5-1.6 million b/d, which could easily cover Iran’s incremental supplies since the lifting of the sanctions averaging around 800,000 b/d, unless there is a wider regional conflict.

Escalating tensions between the US and Iran may produce nervous upticks in crude, but these are likely to be transitory until the Trump administration’s agenda on the nuclear deal is clearer. It won’t be easy for the US to walk away from this multilateral agreement.

© Vanda Insights �4

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Disclaimer: Views and opinions expressed here are for information purposes only and not an offer or a solicitation to sell or buy any physical commodities or financial instruments. The views and analysis are based on reliable public information available at the time of writing. This report and its content cannot be copied, redistributed or reproduced in part or whole without the prior written permission of Vanda Insights.

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Source: OPEC monthly report, citing secondary sources

Rising US inventories. There have been four successive weeks of crude builds.

US dollar — until range-bound around current levels, it will have minimal impact.

Data confirming OPEC and non-OPEC production cutbacks in line with deals.

BULLS AND BEARS