Oil rebound tests its limits

Oil hit a 2015 high on Wednesday and was fast approaching levels not seen since Opec's historic decision in November to hold production steady and fight for market share.

Brent, the international benchmark, rose above $69 a barrel in morning trading, extending its rebound since January to more than 50 per cent.

Crude has been boosted by production shut-ins in Opec-member Libya, a weaker dollar and signs of growing global demand, but the scale and pace of the rally since prices bottomed near $45 a barrel in January has raised questions about its longevity.

Brent is now less than $3 a barrel below the closing price on November 27 - the day Opec decided to maintain production in an effort to claw back market share from higher-cost producers

Opec's plan of curbing higher-priced production, including US shale and ultra deepwater exploration off Brazil, will be threatened if prices break above $70 a barrel and may reignite a global battle for oil market share, say analysts and traders.

In response to weaker prices, US shale producers have cuts costs and improved efficiency, bringing down the price at which they can profitably drill for oil.

"Whether it is vindicated or not the trend has definitely turned and presently bulls are in control of the market," said Tamas Varga of PVM in London, an oil brokerage.

"However, we cannot help but compare the current price strength to the myth of Sisyphus, the king of Corinth . . . condemned by gods to ceaselessly rolling a rock to the top of a mountain only to see it roll back down."

Oil prices averaged more than $100 a barrel between 2011 and last summer before the impact of fast-growing US shale output and slower demand growth sparked one of the biggest sell-offs on record.

The 60 per cent price fall between June and January roiled producer country budgets, gave big importers such as China and India an unexpected boost, and led to concerns about deflation in large economies like the eurozone.

While oil markets remain well supplied, with global production estimated to be outstripping demand by as much as 2m barrels per day, traders have started to look ahead to a possible slowdown in output growth, particularly in the US.

Energy majors have slashed investments in future production, while the number of rigs drilling for oil in the US has fallen by more than half.

Traders said a surprise fall of 1.5m barrels in US oil inventories reported by the American Petroleum Institute overnight had provided further price momentum.

If confirmed by data later on Wednesday from the US Energy Information Administration, the statistical arm of the Department of Energy, it would mark the first weekly drop in US crude oil inventories since January. Last week US crude oil inventories stood at 490m barrels, the highest since records began.

While traders are looking for signs of lower US output, some of the largest shale producers are preparing to respond to the price rally. EOG Resources this week forecast a return to "double-digit" production growth if benchmark US crude rose to $65 per barrel or higher.

"We expect our oil production to return to growth in the fourth quarter, building momentum as we head into 2016," said William Thomas, EOG's chief executive.

The US benchmark on Nymex hit $62.05 a barrel on Wednesday morning, its highest this year.

Saudi Arabia, the world's largest crude exporter and the most powerful member of the Opec cartel, has said it has no plans to change its production policy, which has seen it increase production above 10m b/d as it pushes to expand its share of the global market.

Saudi Arabia's production costs are in the low single digits but it has been forced to dip into its cash reserve to pay for generous social spending programmes.

Riyadh faces rising output from fellow Opec member Iraq, where exports hit a record last month, as well as the possibility of higher supplies from regional rival Iran if a nuclear deal with western powers sees sanctions on its crude exports lifted. Opec is due to meet in Vienna next month and is expected to stick with the Saudi-led policy.

Macro hedge funds and other large speculators have also provided a boost to oil's rally by buying dollar-priced commodities as the greenback has weakened. The US dollar index, which measures the dollar against a basket of other major currencies, has dropped 5 per cent since early March.

In Brent and US crude combined, hedge funds have established a net long position - the difference between bets on rising and falling prices - of almost 550,000 futures and options contracts, according to exchange and regulatory data.

That is the equivalent of more than 550m barrels of oil on paper and one of the largest fund positions on record in crude.

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