Oil markets are falling into a bear trap and it's way overdone: RBC

RBC tells investors to watch out for 'bear traps' in oil market
RBC tells investors to watch out for 'bear traps' in oil market

Oil markets have been prone to over-bearishness of late with fears over supply returning to the market largely "overdone," according to the latest oil market analysis by RBC Capital Markets.

Oil prices are oscillating on hopes that a rebalancing is taking place in the markets and fears of a continuing global oversupply – and the potential for more oil to return to the market from the likes of Libya and Nigeria, producers which have seen supply disruptions.

Helima Croft, RBC's head of commodity strategy and commodity strategists Michael Tran and Christopher Louney said in a note on Wednesday that market caution was overdone, however.

"The oil market recently has found itself in a sort of bear trap. Even as we march closer to the point where the daily global supply overhang turns to a deficit, a deluge of bearish headlines has kept the market on its heels," Croft and her colleagues noted, adding that they "believe that the most significant bearish risks are overdone or have already been largely priced in."

Although oil prices would remain choppy in the near term, RBC said, it maintained its conviction that "oil prices will grind higher through the balance of this year and into next, barring a significant deterioration in the "macroverse."

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RBC believed that Brent and WTI would average $48 a barrel and $49 a barrel in 2016, respectively, and $64/bbl and $66/bbl in 2017.

Giving a reason for such predictions, RBC warned that "investors should remain cognizant of the distress remaining across much of OPEC (namely Nigeria and Libya) and should side-step the numerous bear traps lurking in the market."

Production hikes unlikely

Oil prices have declined steadily since mid-2014 amid a glut in supply and a failure of demand to keep up. The glut has largely been blamed on the 14-member producer group OPEC which decided in November 2014 to defend its market share rather than the oil price (by cutting its own production).

The strategy has put pressure on many non-OPEC producers (who tend to have higher production costs) but it has also hurt OPEC members themselves: Algeria, Venezuela, Iraq, Libya and Nigeria are now known as the "fragile five" due to the loss of oil export revenues, workers' strikes and militancy disrupting production in the latter countries.

Sentiment in oil markets has been hit by fears that once those issues are ironed out, the oil supply in countries like Nigeria and Libya could return with a vengeance, unravelling a delicate rebalancing act in global supply and demand that has seen prices tentatively rise to around the low $40s a barrel.

Investors have also been concerned that Iran's oil supply could quickly ramp up as the country seeks to re-boot its oil industry after the lifting of years of international economic sanctions and elsewhere, there is the belief that U.S. shale oil producers could quickly ramp up production on the back of data showing rising rig counts.

RBC Capital Markets said that those fears were "overdone," however.

While the most fragile OPEC members "remain in a state of distress" and production was not likely to bounce back rapidly, it noted that as for Iran, the "doomsday scenario" of Iranian barrels flooding the market had proved to be "overblown."

As for U.S. production, that too was unlikely to turn the corner until oil prices stabilize in the high-$40/bbl to low-$50/bbl range and that, "in any event, the market should be able to absorb these incremental barrels over the medium term given tightening market balances."

OPEC 'waiting in the wings"

Oil prices rose earlier this week amid news that OPEC is to meet informally in Algeria in late September and that some members could try to persuade the entire 14-country producer group to opt for a freeze in production.

We've been here before, however, with expectations of such a freeze elevated before previous meetings of the group, only to be dashed as members could either not agree on a production freeze or, like Iran, refused point-blank to consider such a move.

Read More OPEC smoke and mirrors' may be all it needs to boost oil

OPEC is due to release its monthly oil market report on Wednesday. It has contended in recent reports that oil markets continue to rebalance as non-OPEC supply falls and global oil demand growth rises.

"Waiting in the wings is OPEC. While it recently has appeared dysfunctional, it still has shown an ability to change market sentiment by simply signaling a willingness to become more engaged in active market management," RBC noted.

It said it believed OPEC's confirmation of a meeting in September showed that it was "ready to go back to the same playbook if it perceives a clear need to firm the price floor" - even if no "concrete action" to support prices is actually taken and the producers prefer to watch and wait if prices continue on their upwards trajectory.