Oil Price Forecast from JPMorgan - Feb 12

[dan_s]

Oil futures have sold off in lockstep with other financial
assets. Yet, incoming data has remained relatively robust, and
all crude oil forward curves remain in healthy backwardation -
an encouraging sign. We still expect oil price risk to be skewed
up in months ahead.

Two factors underpinned our upbeat forecast - backwardation and capital
flows: Oil prices have softened in the last two weeks. So far, the thesis we
presented in The Power of Backwardation (15 Jan 2018) has not played out yet. In
that note, we called for prices to rise further and reach $75 by 3Q. Our argument
was based on two factors: first, we expected the oil market to remain in deficit,
which would lead to inventory draws and keep the forward curve in a
backwardated structure. Second, this offers a positive roll yield which we
expected to attracted capital flows into oil futures, supporting prices along the
forward curve.

The first part of our argument is on-track: backwardation persists...: Despite
volatility in financial markets in the last two weeks, all main crude oil forward
curves continue to show a healthy level of backwardation. This is arguably the
most timely indicator that fundamentals remain robust. Supply/demand data
tends to be lagged but incoming data has supported this: Inventories continued
to draw throughout December, including in the US despite strong shale growth.
Weekly storage data has shown some increases in the last 2-3 weeks but only inline
with seasonal patterns. Floating storage on the other hand is still on a
downwards trend, refining margins recovered throughout January after their soft
patch in December, and OPEC compliance has stayed strong.

...but the second part has suffered - gyrations in other markets have not left oil
futures undisturbed: Between the 1st and the 12th month contract, the Brent
futures curve still offers a roll yield of ~6%. Given that yields in other markets
have risen, this has become comparatively less attractive which will likely have
caused some outflows from oil futures markets. Through this mechanism, oil
prices have peaked simultaneously with equity and bond markets and the trough
in the USD.

Still, we see risk to oil prices skewed upwards: Oil markets were ~0.5 mb/d
undersupplied in 2017, and for 2018 we expect ~1.5 mb/d demand growth. To get
back to an oversupplied market, supply growth would need exceed 2.0 mb/d this
year. With OPEC contributing very little to this, we do not see non-OPEC growing
fast enough to close the gap. This will leave inventories on a downward
trajectory, and keep futures curve in backwardation. Unless other markets
continue to sell off sharply, we still expect that attractive roll yields will
ultimately attract sufficient inflows to drive prices higher, especially after the
recent setback.