Hamza Khan, Head of Commodities Strategy at ING, suggests that after a weak 2015, crude oil started 2016 on another bearish note. Key Quotes “While our base case considers a recovery in crude oil prices by 2H16F, we identify four key factors, which justify the formulation of a ‘lower-for-longer’ scenario that has prices averaging just US$31/bbl in 2017F. 1) Demand disappoints: IEA data shows that oil demand in Organization for Economic Cooperation and Development (OECD) countries increased at a four-year-high rate of 1.7% YoY in 3Q15 to 46.7MMbbls/d, while global oil demand also increased at a four-year-high pace of 2.4% YoY. However, demand growth is still lagging behind the 2.9% growth reported in global oil supply. In the US, although vehicle miles travelled have been increasing at a healthy pace of c.3-4% YoY, the proportionate increase in fuel efficiency resulted in a stable-to-very moderate growth in gasoline demand. In China, a larger industrial slowdown has offset positive growth in automotive fuel. 2) Supply lingers: OPEC crude oil production increased to a record high of 33.1MMbbls/d in January 2016, with spare capacity at a five-year low, as Middle Eastern countries compete against each other for market share. The Saudi and Iranian light oil discount to European buyers increased to a five-year high of US$4.85/bbl, while Russia and the US have managed to maintain production despite a pullback in prices, falling rig counts and labour cuts. Political tensions between Iran and Saudi Arabia have increased since the start of the year after the kingdom’s execution of prominent Shiite cleric Nimr Al-Nimr, hampering concerted action by OPEC. Although high-cost producers, including Venezuela, appear desperate for price support, options are limited, as any production cuts could be compensated by non-OPEC producers (principally the US and Russia) without any material support to prices. 3) Services remain cheap: The oil and gas price sell-off has resulted in significant contract renegotiation for oil field service firms, including lower rig rates and labour costs. The impact is concentrated in North America, where midstream operators have engaged in a wave of merger and acquisition activity to yield lower costs. With midstream services remaining cheap, producers across the world have an incentive to keep pumping oil. 4) Investors exacerbate trends: The net position held by money managers in the NYMEX WTI contract (the number of long contracts held, minus the number of short contracts) has fallen to its lowest point since 2009, suggesting that hedge funds, pension funds and other ‘smart money’ investors are betting on lower crude oil prices. With the number of paper contracts being several orders of magnitude higher than physical barrels, speculator sentiment tied to the dollar or equities can outweigh fundamental marginal price dynamics, depressing prices even if demand rises and production falls.” For more information, read our latest forex news.