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Oil is headed to $30 after Doha

Oil prices are under pressure following the failure of OPEC and major non-OPEC producers to agree on a production freeze at Sunday's meeting in Doha.

We expect Brent crude prices to drop toward $30 a barrel during the current quarter but recover to $55 a barrel in 12 months as the oversupply of oil dissipates towards the end of this year.



Saudi Arabia's Deputy Crown Prince Mohammed bin Salman reiterated before the Doha talks that the Kingdom would not freeze its output without Iran's participation. But the Islamic Republic, unwilling to freeze its output at January levels, did not send a representative to the meeting. Also Iran has made clear that it aims to recoup its lost market share after the removal of nuclear-related sanctions and will resist any OPEC production cap until its production reaches 4 million barrels per day.

While a worker strike in Kuwait, pipeline disruptions in Nigeria and the earthquake in Ecuador might temporarily reduce production in these countries, the latest data indicate that Iranian exports are running at around 600,000 barrels per day and Iraqi exports are about 400,000 barrels per day higher than in March. Meanwhile, Prince Mohammed said the kingdom could increase production to 11.5 million barrels per day from 10.2 million barrels per day immediately if there is demand. Market participants are therefore likely to closely track the oversupplied market and the Saudis' supply reaction.



At the same time, oil demand has come in on the weaker side in the first two months of 2016 following exceptionally strong demand growth in 2016. The warm winter in the Northern hemisphere clearly hurt demand; slower economic growth also might have contributed to this slump. We are sticking to our forecast for an increase of 1.1 million to 1.2 million barrels per day in oil demand this year, but will monitor incoming data over the coming months as weaker demand growth could delay a market rebalancing.

With the oil market remaining oversupplied by 1 million to 1.5 million barrels per day, the burden to adjust remains on non-OPEC producers, particularly the U.S., due to their relatively short lead times between price changes and the supply response. Low oil prices are needed in the current quarter to ensure sufficient capital expenditure cuts, which should enable the oil market to rebalance towards the end of this year. Hence, we expect Brent crude oil prices to drop towards $30 a barrel in the course of the current quarter.

With respect to the longer term, however, capital expenditure cuts are slowly becoming visible. Non-OPEC supply growth (year-over-year) stood at 2.9 million barrels per day at the end of 2014. Supply did not grow in December and January and preliminary data indicate large year-on-year declines in February and March 2016. Low oil prices curbed capital spending worldwide by an estimated 24 percent last year and could trim another 20 percent from capex this year.



This would be the first time since 1986 that investment has fallen two straight years. The plunge in rig counts worldwide, larger production declines in aging conventional oil fields, and project deferrals and cancellations are likely to result in non-OPEC supply contracting by 700,000 barrels per day this year versus a rise of 1.3 million barrels per day last year and of 2.4 million barrels per day in 2014. This would be the first non-OPEC contraction since 2008.

So, OPEC's plan in November 2014 to call on non-OPEC producers to do their part to rebalance the market is starting to bear fruit. But its objective of driving out high-cost producers, which would result in a fully balanced market, has not yet been achieved.

A balanced market at the end of the year is our base case for now, which should enable Brent oil prices to reach $55 a barrel in 12 months. That said, short-term downside price risks, the cost of rolling over futures contracts, and volatility still speak against taking any long positions in crude oil. Risks to our expected price recovery come from a sharp rise in OPEC supply and/or weaker oil demand from emerging Asia, which would push the market's rebalancing into next year.

Commentary by Giovanni Staunovo, a commodities analyst at UBS Wealth Management, which oversees $1 trillion in invested assets. Follow UBS on Twitter @UBS.

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