UPDATE: Should oil really be trading above $60 a barrel?

11/13/17 05:23 AM EST

By William Watts, MarketWatch

Even Saudi risk premium doesn't justify rally: Commerzbank

The oil rally gained momentum last week, taking both U.S. crude and its international counterpart to 28-month highs as political and diplomatic turmoil around Saudi Arabia added a risk premium.

However, some analysts argue that bulls are getting ahead of themselves by underestimating how quickly U.S. shale producers will respond to the rise in prices and overestimating how effective efforts by major oil producers to curb production will be in taming a global oil glut.

"Oil is already much too expensive even if the latest developments in Saudi Arabia justify a certain risk premium on the oil price," wrote Eugen Weinberg, head of commodity research at Commerzbank, in a Friday note.

Oil futures lost ground Friday (http://www.marketwatch.com/story/oil-steadies-after-climb-toward-2-year-highs-2017-11-10) but both Brent , the global benchmark, and West Texas Intermediate crude , the U.S. standard-bearer, their fifth straight weekly gain.

Oil has been in rally mode since late June, buoyed by expectations that global oil inventories will continue to decline after officials from the Organization of the Petroleum Exporting Countries, or OPEC, and Russia's energy minister indicated they will move to extend the existing agreement on production curbs beyond March 2018.

In what The Wall Street Journal dubbed a "top-down revolution," (https://www.wsj.com/articles/saudi-prince-shakes-royal-family-with-crackdown-1510335434) numerous members of the Saudi royal family and government officials were arrested last weekend in an ostensible corruption crackdown seen as a bid by the country's powerful Crown Prince Mohammed bin Salman to consolidate power.

See: What Saudi Arabia's purge of ministers, princes--including the Buffett of the Middle East--means for markets (http://www.marketwatch.com/story/what-saudi-arabias-purge-of-ministers-princes-including-the-buffett-of-the-middle-east-means-for-markets-2017-11-06)

Also read:Trump voices support for Saudi shake-up, as Iran accuses U.S. of meddling (http://www.marketwatch.com/story/trump-voices-support-for-saudi-shakeup-as-iran-accuses-us-of-meddling-2017-11-06)

Also, Yemeni rebels launched a failed missile attack last Saturday on Riyadh's international airport. Saudi Arabia has said the rebels are backed and armed by Iran and that it considers the attack an act of war (http://www.marketwatch.com/story/saudi-arabia-blames-iran-for-missile-attack-calling-it-an-act-of-war-2017-11-06). Saudi Arabia and its Gulf allies this week have also urged their citizens to leave Lebanon, escalating a dispute over the influence of Iranian ally Hezbollah in the country.

See:Saudi Arabia says Lebanon has declared war on it (http://www.marketwatch.com/story/saudi-arabia-says-lebanon-has-declared-war-on-it-2017-11-06)

The fact that internal turmoil and the renewed specter of conflict between longstanding rivals Saudi Arabia and Iran is being cited as a factor lifting oil prices marks a return of geopolitical risk as a factor for the market. For years, since crude's collapse from more than $100 a barrel in mid-2014, oil has been largely unresponsive to potential threats to output in the Middle East, with traders instead focused on a stubborn supply overhang.

But Weinberg argued that market participants had already gotten ahead of themselves. He estimated the Brent price "is currently too high by at least $10" a barrel.

He argues that based on estimates by the International Energy Agency, there should be only a marginal fall in oil stocks in the fourth quarter and even a potential rise in the first quarter of 2018. With OPEC production sustained at its current level, the global oil market would be "roughly balanced" until the end of 2018.

Meanwhile, OPEC forecasts that despite a stronger-than-expected rise in global oil demand, the demand for OPEC oil will be only just above current production in coming years, he noted. That is because non-OPEC supply should increase sharply, especially from U.S. shale producers.

"At a WTI price of well over $50 a barrel, drilling activity should pick up again," he said.

Analysts at Capital Economics, meanwhile, said that even if OPEC extends cuts to the end of 2018, inventories are likely to exceed their five-year average, "which should put some downward pressure on oil prices next year. "

However, the efforts are closer to bringing the stocks-to-consumption ratio in developed countries back to its average, they said. (See chart below)

The U.S. rig count rose in the past week (http://www.marketwatch.com/story/oil-futures-remain-lower-after-rise-in-weekly-us-rig-count-2017-11-10), Baker Hughes(BHGE) reported Friday, putting the total number of oil rigs at 738. The number of rigs drilling for oil had declined this summer, but Weinberg argued the fall was due to a retreat by futures seen when prices fell after OPEC agreed at the end of May to extend the production cuts to March 2018.

The same sell-the-fact scenario could happen again, he said, with prices succumbing after the Nov. 30 OPEC meeting.

"Like six months ago, an extension of the production cuts would no longer come as a surprise and could therefore lead to profit-taking by speculative financial investors," he said.

-William Watts; 415-439-6400; AskNewswires@dowjones.com

 

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11-13-17 0523ET

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