Oil back on defensive as Iran gets ready to unleash

Ole Hansen, Head of Commodity Strategy at Saxo Bank

MANAMA: The pre-Christmas rally in crude oil has ground to a halt as the countdown to the New Year starts. Iran is gearing up to flood the market with 500,000 barrels/day within weeks of sanctions being lifted while the ceasefire in Libya may also add extra barrels, according to Ole Hansen, Head of Commodity Strategy at Saxo Bank.

Brent crude oil’s premium over WTI has evaporated with the lifting of the US export ban shifting the oil glut focus to the global market.

WTI crude oil rallied by 6.4% ahead of the Christmas break while Brent managed to rally by 5%. The out-performance of WTI was triggered by the biggest weekly drop in US inventories since June and the continued focus on additional supplies from Iran which will add to the existing global supply glut of oil.

Brent crude oil’s long held premium over WTI crude has evaporated at the front end of the futures curve. With additional barrels from Iran hitting the global market within weeks, the focus on supply glut has shifted from the US to the global market.

US crude oil inventories shrank by almost 6 million barrels during the week of December 18 but as the chart below shows, this is in line with seasonal behaviour. US inventories are currently some 125 million barrels higher than the five-year average and could hit a new record high during the first quarter when inventories tend to rise.

Rising US inventories during the shale oil revolution since 2010 did at times put WTI crude oil under pressure relative to other oil benchmarks, such as Brent crude (chart above)? But the lifting of the US export ban which had been in place since the 1970s has created an escape valve for US producers and the price of WTI has realigned with international prices.

While Opec crude oil production, especially from Iran, is expected to rise over the coming months, recent media reports are pointing towards rising stress among US producers which eventually is expected to translate into lower production.

However before that impact is felt, the upside potential for oil remains limited to those stemming from short covering from hedge funds and money managers holding large speculative short bets against oil, both in Brent crude and WTI crude. The latest Commitment of Traders report (COT) from the CFTC covering the week ending December 22 will be released today at 3:30 Eastern Time.

Brent crude ($37.25/b -1.7% at 8:30 GMT) is currently down by more than one-third this year. This especially after a very challenging final quarter which has left the price way below the average for the year at $54/b.

The first quarter of 2016 is going to be another challenging period with inventories in the US rising at the same time as increased supply from Iran and potentially also Libya hit the market. Supply will eventually adjust to lower prices and lower profitability but so far producers, especially in the US have shown a great deal of resilience.

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