Crude Prices Surge, but Analysts Warn that Oil Approaching $60 May Spur a New Wave of Overproduction

Experts say a widening WTI//Brent spread is sending mixed signals about the true supply/demand status. File Image / Pixabay

The best closing price in five months of U.S. crude  was achieved on Monday as West Texas Intermediate surged by $1.56 to settle at $52.52 per barrel, reportedly buoyed by improving demand and the persistent hope that the Organization of the Petroleum Exporting Countries (OPEC) will later this year agree to extend its output reduction initiative beyond next March's expiry date.

Brent enjoyed an even greater gain Monday: it rose $2.01 to $58.87, the highest level since July of 2015.

But as crude nears $60 per barrel, Francisco Blanch, head of global commodities and derivatives research at Bank of America Merrill Lynch, warned that exporters whose budgets are dependent on oil revenues will be tempted to pump above agreed-upon levels, thus upsetting a fragile market rebalance that has only just begun: "Even at these prices levels, they're still bleeding cash, so they want more money and I think the incentive to stay together starts to decrease."

Blanch was referring to members of OPEC, which he credits for pushing Brent's market structure into backwardation, whereby prices for future delivery are cheaper than the cost of oil for immediate shipment.

Dino Kronfol, chief investment officer for global Sukuk and MENA fixed income strategies at Franklin Templeton ME, told Bloomberg that the OPEC cuts "seem to be sticking in" and will cause "oil prices to remain firm" going into 2018 - although he didn't predict what the high end of the price range could be.

Conceivably, prices could rise beyond $60 if the latest findings from Citigroup Inc. prove valid: on Monday it said that five OPEC members - Libya, Nigeria, Venezuela, Iran, and Iraq - are already pumping at their maximum capacity and that weak investment in exploration and development could lead to a supply shortage as early as next year.

Ed Morse, global head of commodities for Citigroup, remarked, "We're seeing more and more evidence that it's not the international oil companies, it's not the independent oil companies that are lagging new investments, but it's OPEC countries lagging, particularly those five."

The question is, what is the true state of global supply balances?

On that score, Reuters reports that some oil traders are puzzled by Brent's strength reflecting tighter supplies due to the OPEC cuts, while the U.S. market continues to signal large oversupply; however, Michael Tran, director of global energy strategy at RBC Capital Markets, isn't overly worried by the unusual phenomenon: "When you look at the Atlantic basin, supplies are getting tighter, especially with more West African (crude) moving to Asia and floating storage disappearing.

"In time, WTI will play catch up as North America balances firm" - and again, if proven true, this could mean higher prices.

Tran is among a growing number of experts who are reporting declining inventories in many parts of the globe: last week Marco Dunand, chief executive officer for Mercuria, said, "The market is selling inventories from everywhere" in reference to Total SA and other companies selling crude that was hoarded in Saldanha Bay, South Africa.