HardAssetsInvestor

Written by Sumit Roy  |

July 18, 2012

Brent On Target For $110 After Topping $105 As OPEC Spare Capacity Dwindles

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The recovery in oil markets continues.

The Department of Energy reported this morning that in the week ending July 13, U.S. crude oil inventories decreased by 0.8 million barrels, gasoline inventories decreased by 1.8 million barrels, distillate inventories increased by 2.6 million barrels and total petroleum inventories increased by 1.4 million barrels.

Crude prices continued to rally over the past week. Today Brent topped $105 for the first time since May. WTI has lagged amid persistent infrastructure constraints in the Midwest, but it too has moved higher.

Why is oil now trending higher after trending lower for the past few months?

BRENT

WTI

In our view, the steep 30 percent drop in Brent prices from April into June was due to a combination of weakening economic growth in Europe, the U.S. and China, as well as rapidly rising output in OPEC and the U.S.

Indeed, the supply side in particular caught the market off guard. Despite plunging supplies from Iran—the country’s exports are down by half from their normal levels—OPEC’s output as a whole is at four-year highs thanks to elevated output from fellow members Saudi Arabia, Iraq and Libya.

But while a correction was warranted, as often happens, prices became overextended on the downside. Moreover, the long-term bullish fundamentals of the oil market didn’t change.

Though OPEC output is at four-year highs, the flip side of that is that OPEC’s spare capacity is at four-year lows, near 2.4 mmbbl/d.

Low levels of OPEC spare capacity—the buffer against shocks in the oil market—has been one of the key underpinnings of the long-term bull market in oil prices over the past decade.

As long as spare capacity continues to trend down, in our view, prices will trend higher.

Our next objective on Brent is the $110 level, which we anticipate will be met in the coming weeks and months.