Oil prices could test $20 per barrel: Vandana Hari

Interview with Asia editorial director at Platts

After slipping to $28 per barrel levels earlier this year, Brent crude oil prices have bounced back to over $40 levels over the past couple of weeks, only to slip again. Vandana Hari, Asia Editorial Director at Platts, and Research Scholar, McGraw-Hill Financial Global Institute tells Puneet Wadhwa that going ahead, it is possible for oil prices to touch new lows.

"The recent heightened tensions between Saudi Arabia and Iran, and the latter insisting it needs to be allowed to reach its full output potential, also makes an agreement on production freeze difficult," she says. Edited excerpts:

After regaining $40 a barrel levels, crude oil prices (Brent) have dipped again. What is your interpretation of the developments?

The earlier fall and the subsequent rally, to a large extent, were both sentiment driven. Back in January, there were concerns, and fear and panic in the stock markets over weak Chinese economic data, the devaluation of the Yuan, and the ripple effect of the slowdown in the world's second largest economy, which put a question mark on growth in global oil demand. It was difficult to connect the dots to oil demand, but we saw a knee-jerk reaction in the oil markets.

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Another major factor in January was the lifting of the sanctions against Iran and expectations of more oil flowing from that country. There has been more rhetoric rather than a rational calculation of how much can Iran can realistically put into the market. However, now the market has some data to look at, which confirms a consensus view that Iranian oil's return to the market will be much smaller and slower than anticipated earlier.

A lot of market participants would have considered oil to be 'oversold' at the recent low levels and covered their short positions. That's the reason it regained $40 levels. The other reasons that supported a rise in prices included an outage of a key pipeline that transports Kurdish crude to the Turkish port of Ceyhan, violence in Nigeria's Niger Delta that curbed crude supplies, and field maintenance in the UAE. These events collectively took out around 800,000 barrels per day from global oil supply. All these factors helped oil prices gather steam.

Why are the stock markets reacting so sharply to oil price movement?

We have seen a very close correlation - though not causality - between the stock markets and oil prices in recent months. This in turn tells us that both the segments are being guided by economic sentiment.

Have the oil prices bottomed out? Do you foresee a pick-up in demand anytime soon?

The recent uptick in crude was likely a temporary bottom, as a production freeze agreement between major oil producers doesn't mean much given the current oversupply, and the possibility of a production cut remains even more remote. So in terms of fundamentals, nothing much has changed for oil prices to move up.

It is too early to revise our expectations on oil demand growth. The IEA is still projecting a 1.2 million barrels per day growth in global consumption this year, which is much lower than what we saw in CY2015. With fresh economic troubles in Europe (ISIS, Brexit etc) there is now a question mark on European oil demand as well.

Can oil go back to $20 levels again?

Absolutely, we can hit those levels again. It is possible for oil prices to touch new lows. To my mind, what is more important is prices sustaining at those levels. Unless prices are sustained at those painfully low levels for a period of time, we will not see the marginal, high cost oil stay off the market, which is what is needed to reach an equilibrium.

Where do you see oil prices (Brent and WTI) averaging out over the next one year?

Well, Brent could definitely test $20 again. However, it is difficult to say where prices will average this year. There is a view in the markets that the second half of CY2016 will be dramatically different from the first half. While in the first half we are moving around 1.5-2.0 million barrels per day into storage, the surplus is expected to shrink substantially in the second half. If the decline in US oil production accelerates and takes off more than the 700,000 barrels per day compared with 2015 average that is currently projected by the US Energy Information Administration, we could see Brent ending the year well above the $40 a barrel mark.

How much rates hike by the US Federal Reserve (US Fed) are the prices factoring in at the current levels?

An imminent US Fed hike would likely result in dollar strength, and likely dampen oil prices once again. The dollar strength is actually a bit further from the minds of oil industry players as they focus on other moving parts in the scheme of things that determine oil prices. The consensus view is of one rate hike in CY16, but it is a relatively smaller contributor in the movement and volatility in oil prices at this point in time. Had the Fed stayed on course for four rate hikes in CY16, it would have added far more volatility to oil prices.

How are the oil markets viewing the macro data from China and Europe?

Developments in both these geographies is quite hard to read. China has been trying to reduce its energy intensity - in other words, how much incremental energy it uses to increase its GDP. The other major shift happening in China is that the demand is shifting to lighter / consumer fuels like LPG, jet fuel, naphtha and gasoline. Demand for diesel, on the other hand, is flat lining. China's implied oil demand, according to Platts calculations, grew 5.8% year-on-year in 2015. This year, we expect the growth in oil demand to continue, but the rate of growth will be substantially lower at 2.4%.

As regards Europe, oil demand saw an uptick last year, according to the IEA. Europe was not expected to contribute to the growth in oil demand this year. However, given the fresh set of problems that have engulfed the continent, the demand may even decline.

How do you see the OPEC (Organization of the Petroleum Exporting Countries) respond to all these developments?

We have to recognize that OPEC is largely led by Saudi policies. There is no semblance of unanimity or agreement within OPEC right now as to what they should do. Member countries like Venezuela, Algeria and Nigeria are suffering far more than the relatively more cash-rich fellow OPEC members in West Asia.

The recent headlines over a production freeze and continued calls for a production cut from some of OPEC's members notwithstanding, I believe OPEC will stick to its market share strategy. It is easy for us to say a production cut (is needed) than for them to actually contemplate, let alone implement int. They don't have individual member country quotas anymore. So a production cut is virtually ruled out. And given the current oversupply, holding output at January levels will not address the imbalance in the market.

The recent heightened tensions between Saudi Arabia and Iran, and the latter insisting it needs to be allowed to reach its full output potential, also makes an agreement on production freeze difficult. Most countries that have agreed to it have made it conditional on all major OPEC and non-OPEC producers accepting it.

What are the global inventory levels now compared with, say a year ago?

Total OECD oil stocks are sitting at all-time highs well above three billion barrels, according to the IEA. And stockbuilds also happened outside the OECD toward the end of 2015, most prominently in China. As of end-February, about 72 million barrels of oil was also stored on water, according to the latest monthly report by the International Energy Agency. OECD crude stocks are sitting around 200 million barrel above the five-year average, while refined product stocks are about 90 million barrels above the five-year average.