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The recent OPEC’s agreement to cut output by 1.2 Mb/d from January next year together with the possibility of non-OPEC cuts of some 600 kb/d should result in meaningful global oil stock draws next year (even if full compliance is unlikely).
Therefore, we foresee the scope for WTI to approach $60 by end-17. Annual global oil demand growth is forecast at a healthy 1.25 Mb/d in 2016 and 1.26 Mb/d in 2017, driven by emerging markets, especially China, India, and other non-OECD Asia. US output continues to be an important driver for non-OPEC supply as a whole.
Annual US liquids production including crude and NGLs is forecast to decline by 0.48 Mb/d in 2016, but to reverse course and increase by 0.16 Mb/d in 2017. Annual US output of crude (only) is projected to contract by 0.57 Mb/d in 2016, but to decline by a smaller 0.16 Mb/d in 2017.
The shale is expected to stop supply, declining and bottom out in Q2’17 and Q3’17, before starting to gradually grow again in Q4’17. Most shale oil full-cycle production costs are down some 30% since Q4’14 and are centred around $40-45 (WTI equivalent).
WTI has averaged in the $45-50 range since Q2’16 and due to the persistent contango on the forward curve (front-month vs one-year forward timespreads have consistently been in the $3-6 range), producers have been able to lock in higher prices through hedging (selling forward). As a result, US E&P capital spending has begun to stabilise with gradual increases expected; US oil directed drilling has been gradually recovering since June. The prospect of a gradual recovery in US shale production next year is likely to slow the uptrend in oil prices.
We recommend 3m at the money +0.51 delta call options to hedge upside risks of WTI crude prices. We encourage delta instruments here as the higher (absolute) delta value is desirable for an ATM option buyer when you are more aggressive about the direction of the underlying spot but gutsy to digest if it slightly forgoes against you, whilst a delta close to zero is desirable for the option seller; a buyer wants their option to become more valuable whilst a seller wants the option to become less valuable.
Alternatively, buying futures contracts of Dec-17 WTI on dips with a target at around $60.
