Oil Price Outlook | Stratas Advisors

What's Affecting Oil Prices This Week?

Our Short-Term Price Outlook service covers a period of eight quarters and provides monthly forecasts for crude oil, natural gas, NGL, refined products, base petrochemicals and biofuels.

At the beginning of last week we forecast that the price of Brent crude would approach $48.50 per barrel (/bbl). The forecast was based, in part, on the expectation that oil traders were shifting back to a more optimistic view of the oil market with the renewed rumors of a potential OPEC deal, which would reduce oil production. We also expected additional support from elevated crude runs because of relatively wide crack spreads. Together, we expected these factors would partially outweigh the impact of the strong US dollar. Our forecast aligned with the direction of the actual price movements, and in fact, the price of crude oil moved more positively than forecasted until the end of the week. The price of Brent crude started the week at $46.86/bbl then jumped to $49.12/bbl by the middle of the week and stayed near $49/bbl before falling back on Friday to close the week at $47.24/bbl. The movement of the oil prices followed the news associated with the potential OPEC deal. The significant decline on Friday (3.59%) appeared to stem from the news that Saudi Arabia would not be attending the meeting on the upcoming Monday with non-OPEC- producers. News that Saudi Arabia was intending to increase exports to Asia in January further dampened the oil market. We also forecast that the Brent-WTI differential would continue to trade between $0.50 and $1.00 with respect to the January contract. In actuality, the Brent-WTI differential started the week at $0.50 then jumped to $1.09 on Tuesday, and stayed in the vicinity of $1.00 before widening on Friday to close the week at $1.18. For the upcoming week we are forecasting that the price of Brent crude will stay relatively flat for the first part of the week and then decline with support at $45.50. We are also forecasting that the Brent-WTI differential will continue to trade between $1.00 and $1.50 with respect to the February contract.

Page 1 of 5 © 2018 Stratas Advisors. 1616 South Voss Road Suite 675 | Houston, TX 77057 | United States | +1.713.260.6426 | stratasadvisors.com The supporting rationale for the forecast is provided below.

In the aftermath of the election of Donald J. Trump our Macro-level Team continues to assess his view of policy-related issues and the possible implications. This week we are highlighting Trump’s naming of retired Lieutenant General Michael Flynn, former head of the Defense Intelligence Agency, as his National Security Advisor. Given his impressive operational- and strategic-level experience, the strong national security credentials he provided to a presidential candidate who has no policy experience himself, and the rapport he may have with President-elect Donald Trump given some of the commonalities they have in terms of their rebellious personalities and strict upbringings, General Flynn's views of critical international issues including the Iran nuclear agreement and broader U.S.-Iran foreign policy disputes are likely to substantially influence Trump. In particular, General Flynn would appear to be a proponent of taking a more aggressive stance with Iran. In his book, The Field of Fight: How We Can Win the Global War Against Radical

Islam and Its Allies, General Flynn provides significant details on his views of complex policy matters, including U.S.-

Iran relations. He asserts, "The ties between the Iranian regime and al Qaeda have been a well-established fact ever

since the autumn of 1998, when the American government indicted the organization and its leader, Osama bin Laden."

That year, al Qaeda claimed responsibility for two bombings against U.S. embassies in Kenya and Tanzania. Flynn writes that these were "in large part Iranian operations", "the al Qaeda terrorists were trained by Hezbollah in

Lebanon, and the explosives were provided by Iran. After the attacks, one of the leaders of the operations, Saif al-

Adel, took refuge in Iran, where he remains active in operations as of this writing." A more aggressive stance by the

Trump administration could have significant impact on the oil markets. Since the lifting of the sanctions, Iran has been

Page 2 of 5 © 2018 Stratas Advisors. 1616 South Voss Road Suite 675 | Houston, TX 77057 | United States | +1.713.260.6426 | stratasadvisors.com able to increase its oil exports by more than 700,000 barrels per day (bbl/d). In effect, the increase in Iranian oil exports replaced the decrease in production from US shale producers. While the re-imposing of sanctions on Iran will be difficult, given that it is highly unlikely that China and Russia will offer their support, it is possible that the U.S. could discourage investment in the Iranian oil sector – especially with respect to the western oil companies. Heretofore, Iran has been able to ramp production back up to pre-sanction levels without the need for capital investment. Further material increases in sustainable production will require capital investments. For the upcoming week, we are maintaining our view that the geopolitics will be a neutral factor with respect to the price of Brent crude.

At the beginning of last week we forecast that the US dollar would move sideways with respect to the euro with the US dollar reaching its highest since November 2015. Our forecast aligned closely with the actual movement of the US dollar. The US dollar started the week at 1.059 with respect to the euro then stayed essentially flat throughout the week to close the week at 1.058. Looking forward to the upcoming week we are forecasting that the US dollar will trade between 1.055 and 1.065 with respect to the euro. One reason for the expected stability is that currency traders have already factored in a rate increase in December by the Federal Reserve. Therefore, we are maintaining our view that the US dollar will be a neutral factor with respect to the price of Brent crude.

Prior to the beginning of last week we expected that oil traders would be shifting to a more optimistic view with the renewed hope of an OPEC deal to reduce production. The traders did appear to react positively to a potential deal; however, by the end of the week the hope of a deal was dampened. The dampening was the result of Saudi Arabia pushing back on a meeting between OPEC and non-OPEC that has been proposed to occur on this upcoming Monday. Additionally, the actions of Saudi Arabia with respect to the guarding of its market share is not consistent with someone who appears to be ready to take the lead in cutting production. That said, while we remain highly dubious of a deal that results in actual meaningful production cuts, we expect an agreement will come out of the upcoming OPEC meeting. Once examined, however, we do not expect that oil traders will consider the announced deal as a positive development. For the upcoming week we are shifting our view that the sentiment of oil traders will be a positive factor to a neutral factor with respect to the price of Brent crude.

Last week the number of operating oil rigs increased by three, according to the weekly report from Baker Hughes. The number of operating oil rigs now stands at 474, which compares to 555 for the same time period of the previous year.

During the month of November, operators have added 33 rigs – the most since July of this year when oil prices broke

above $50/bbl. Furthermore, the number of operating oil rigs have rebounded from the low of 316, which occurred in

May of this year. The U.S. Energy Information Administration (EIA) reported that U.S. production during the week before was 8.69 million barrels per day (MMbbl/d) – essentially unchanged from the previous week; but nearly 240,000 bbl/d from the low that occurred at the end of June of this year. The pattern of U.S. production illustrates the

dilemma facing OPEC producers. Once oil prices move into the vicinity of $50/bbl the shale producers increase their

drilling activity and production. The empirical evidence has established this reaction as a factor that will remain a

Page 3 of 5 © 2018 Stratas Advisors. 1616 South Voss Road Suite 675 | Houston, TX 77057 | United States | +1.713.260.6426 | stratasadvisors.com structural part of the oil market for the foreseeable future. A downturn in oil prices provide for only a temporary reduction in shale-related production, which will return quickly once prices recover. Consequently, any efforts by OPEC to increase the price of oil needs to take into account the extent of the resulting rebound in shale-related production in comparison to demand growth and production from other non-OPEC sources. One critical factor pertinent to the assessment is break-even costs associated with the different production sources. Our Upstream Team (insert link to landing page) has recently completed a study of the break-even price of oil-development projects that include some 350 oil assets covering key categories across the globe, weighing them by estimated 2P reserves on a boe basis and 10% return basis (https://stratasadvisors.com/Insights/111416-Break-even-Oil-Price). Key findings from the study include that Canadian oil sands, with a price of about $57/bbl, and a range of $36/bbl to $100/bbl, tops the list as the most expensive of current development types. The GOM Lower Tertiary developments have an average break-even of $55/bbl with a range of $42/bbl to$88/bbl, which tops all other offshore deep and ultra-deep water developments around the world. U.S. shale oil plays follow relatively close behind with a weighted average break-even price of about $51/bbl. Results from the study indicate that the basis for oil prices going higher from here will be the ability of OPEC to accommodate additional supply from Iraq, Iran, Libya and Nigeria, such that the expected rebound in shale-related production does not exceed the increase in oil demand. With the OPEC meeting scheduled for Wednesday, we are expecting that OPEC will announce a deal, but without sufficient details with respect to implementation of production cuts – which will ultimately disappoint the market. As such, we are shifting our view that supply will be a neutral factor to a negative factor with respect to the price of Brent crude.

The supply of gasoline to the U.S. market (proxy for oil demand) fell to 9.024 MMbbl/d, according to the EIA. The level of supply was a drop-off of 335,000 bbl/d from the week before, but was 103,000 bbl/d greater than for the same time period of the previous year. In contrast, the supply of distillate fuel oil to the U.S. market reached 4.121 MMbbl/d, which was an increase of 177,000 bbl/d greater than for the week before and 421,000 bbl/d greater than for the same time period of the previous year. From an inventory perspective – U.S. inventories of gasoline increased by 2.32 MMbbl, while inventories of distillate fuel oil increased by 327,000 bbl. The increase in product inventories was driven, in part, from the rebound in refinery runs before the Thanksgiving holiday week. Crude inputs to refineries increased to 16.397 MMbbl/d, which was an increase of 271,000 bbl/d in comparison to the week before. Outside of the U.S.

product inventories decreased in the northwest Europe with gasoline inventories decreasing by 470,000 bbl and gasoil inventories decreasing by 550,000 bbl. In southeast Asia, inventories of light distillates decreased by 372,000 bbl and inventories of middle distillates decreased by 952,000 bbl. For the upcoming week we are shifting our view that demand will be a neutral factor to a positive factor with respect to the price of Brent crude.

Prior to the beginning of the last week we expected that the refining sector would be supportive of crude prices because of the relatively wide crack spreads. In actuality, the refining sector was supportive of oil prices, as indicated by the elevated utilization rates, including in the U.S. Last week while refining margins were essentially flat in southwest Asia and northwest Europe they remained relatively high. Refining margins in the Gulf Coast region of the U.S.

Page 4 of 5 © 2018 Stratas Advisors. 1616 South Voss Road Suite 675 | Houston, TX 77057 | United States | +1.713.260.6426 | stratasadvisors.com rebounded back to the range that has been the norm since September of last year. Looking forward to the upcoming week we are expecting the refining sector to continue to be strong in Asia, Europe and the U.S. Therefore, we are maintaining our view that refining will be a positive factor with respect to the price of Brent crude.

Before the beginning of last week we forecast that the Brent-WTI differential would continue to trade between $0.50 and $1.00 with respect to the January contract. In actuality, the Brent- WTI differential started the week at $0.50 then jumped to $1.09 on Tuesday (with the shift in the WTI contract from December to January), and stayed in the vicinity of $1.00 before widening on Friday to close the week at $1.18. We also forecast that crude inventories in the U.S. would increase between 500,000 bbl and 1.50 MMbbl. In actuality, crude inventories decreased by 1.26 MMbbl. The decreased stemmed mainly from the drop-off in crude imports, which fell to 7.58 MMbbl/d – a decrease of 845,000 bbl/d less than in the previous week. For the upcoming week, we are expecting that crude inventories will be essentially unchanged. We are also expecting that the Brent-WTI differential will continue to trade between $1.00 and $1.50 with respect to the February contract.