During the first six months of 2016, it looked as if oil prices were back on their way to $80 or even $100 a barrel as demand surged and supply started to fall. However, over the past few weeks oil prices have erased almost all of the year-to-date gains and analysts are once again competing over who can publish the lowest justifiable price target.

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In a research booklet sent out to clients at the beginning of this week, Societe Generale oil analyst Michael Wittner tries to explain why oil prices are now on the back foot, and why investors shouldn’t hold any hope for higher prices in the near-term.

Fundamentals indicate lower prices 

There are two main reasons why oil prices moved higher in the first half. Firstly, supply disruptions led by Canada and Nigeria took nearly two million barrels a day of supply out of the market, which helped balance the global oil market. Secondly, the International Energy Agency predicted that the massive global oversupply would come to an end this year as the oil market balanced.

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Both of these factors have now become redundant. The 1.2 to 1.3 million barrels a day of Canadian output lost to the Alberta wildfires has returned to the market and while Nigerian disruptions continue the current level of shut-ins is 200 kb/d below its peak. Further, while there was some degree of market balancing seen in the first half, oil inventories remain elevated with slight builds in the US during May and June.

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In recent weeks a third factor has emerged to play a role in oil’s price correction. Gasoline stocks remain elevated putting pressure on gasoline cracks and overall refining margins. Weak refining margins appear to be dampening crude buying sooner than usual ahead of the end of the peak driving season. Moreover, the weakness in product cracks and refining margins has led to questions about the health of product demand. Figures suggest that global product demand growth is healthy, but growth is decelerating. Consensus estimates that demand growth will fall from 1.5 Mb/d in the first half of 2016 to around 1.2 Mb/d during the second half.

Oil prices will follow the path of least resistance
Oil prices will follow the path of least resistance

Oil prices will follow the path of least resistance

And after considering all of the above Michael Wittner and team believe that, in the near-term at least, the price of oil will follow the path of least resistance:

“While we are bullish for next year, we continue to be cautious for the rest of this year. Weak refining margins around the world, upcoming seasonal weakness for both crude and product demand, and high global inventories are all reasons for caution on prices – and a broadly balanced global market won’t do much to change the inventory picture. Given the absence of a near-term bullish fundamental or geopolitical catalyst, for the time being, the path of least resistance for oil prices continues to be lower.

Having said that, we also believe that there is a limit to this correction. We expect crude prices to bottom out in the high $30 range. We do not think that we will return to $35 or $30 or $26-27, as we saw in Q1 16. The key difference between then and now is that in Q1 16, global stocks were building by 1.3 Mb/d. Now, global supply and demand are roughly balanced, in large part due to steadily declining US crude production. This continues to underpin our view that the global market has shifted from massive oversupply to broadly balanced in H2 16 and H1 17.” — Societe Generale