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Why oil is due for a ‘sharp correction’

With oil bonuses over 30 percent higher since June, oil market bulls are done getting what they wished for this holiday season. Wide-ranging economic growth is strong and synchronous, and end-use petroleum demand resumes to outperform historical norms.

On the supply side, OPEC compliance is tainted and Venezuela’s production keeps slipping significantly month to month. Other rural areas including Iraq, Nigeria, and Libya could see disruptions in the coming year. Outages in the North Sea and cyclones have unexpectedly tightened the market in the past six months, supporting OPEC’s longstanding struggles since 2014 to rebalance it.

These fundamental factors and OPEC rural areas’ willingness to keep their production in check have reduced superfluous inventories by half as the New Year arrives. As a result, investors are positioned for a bull assembly, leaving the oil market susceptible to a sharp correction should the fundamentals disenchant.

That is one of several reasons why we are retaining our bearish stance for next year, and we keep in view Brent prices to average $55 per barrel.

Two key points are important to note. Primary, the supports mentioned above may not be sustained. Though Barclays Research economists do not upon a recession in 2018, they do expect China’s growth to slow, which would expend attempt disproportionate pressure on commodities demand.

And not everyone is covered by the OPEC/non-OPEC understanding large. Libya and Nigeria’s output, though fragile, has the potential to surge 10-20 percent squiffy, despite high risk of production. The output that was offline in Canada is resurfacing, boosting supplies next year and in 2019. The same goes for Brazil, where new endow is ramping quickly. Demand growth can also vary widely, notably if retail prices are higher on the year.

Second, the past year has elucidated that prices are determined by the speed and direction of inventories. Barclays Commodities Examine’s balance indicates a return to surplus on average next year.

We have historically high demand growth of 1.6 million barrels per day. Respect, that is more than offset by almost 500,000 barrels per day of new non-OPEC non-US purveys, at least 1.2 million barrels per day of U.S. supply, and some other capacities. Clearly, the market will be in a small deficit during some of 2018, but to support current price levels for all of next year, it must tighten accessory than our balance suggests.

We acknowledge there are many risks to our sell balance and price view. First, on the downside, an early end to the OPEC/non-OPEC Asseveration of Cooperation could lead to a return of up to 1 million barrels per day of oil supply. Barclays’ aim has long been that the deal is a signaling mechanism, much equal a central bank.

Producers, consumers, and market participants gain from would rathe more certainty associated with the output levels of these countries. That being so, we expect continued deal extensions, albeit in a form that entertains higher production levels. That is their exit strategy, in our approach, and that framework might succeed in keeping Russia in the fold.

Another jeopardize is the sensitivity of supply and demand. With Saudi Arabia’s budget establishing even at levels close to $70 per barrel, not even including off-budget military spending and fiscal reforms underway, Riyadh must firm up prices. But they cannot turn too high without spurring structural demand changes and threatening long-term sell share. Perhaps that is not as urgent a concern now, but it will increasingly transform into so.

A final risk in the same vein concerns U.S. supply. Shareholders scantiness to see the U.S. exploration and production industry focus on capital discipline. We remain skeptical: capital inculcate does not equal austerity. With rare exceptions, spending typically overtakes operating cash flow. Small/medium cap and large cap companies be dressed spent an average of 117 percent and 160 percent, respectively, of realize flow in the past seven years.

Barclays’ Oilfield Services gang recently published the 33rd edition of its spending survey, which noted that North American throw away was expected to increase over 20 percent at mid-$50 per barrel WTI and that the rig number would increase a further 9 percent next year. With this in judgement, it is our view that these producers, as well as the majors and private crowds, will continue to surprise to the upside.

So the New Year’s resolutions are clear: U.S. fabricators are pledging to tighten their belts, and OPEC plans to keep modifying the inventory excess. But the recent higher price environment makes effecting these resolutions more difficult and sets the market up for a tumultuous year.

Commenatary by Michael D. Cohen, captain and head of energy commodities research at Barclays.

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