Crude Oil:On Negative Watch

　　Oil prices around USD 30/bbl mean that an increasingly significant volumeof future oil projects no longer make sense. The fact that oil companiesare postponing USD 380bn of capex will mean that 1.5 mmb/d ofproduction which was originally meant to arrive on the market in 2021 willno longer be developed.

　　Importantly, incentive cost breakevens for these postponed projectsremains at an average Brent price of USD 64/bbl for deepwater projects,USD 55/bbl for shallow water projects, and USD 58/bbl for onshore and oilsands projects.

　　A further 10% deflation in US onshore tight oil breakevens means that ourprice expectations have now been lowered by USD 3-5/bbl, leaving ourWTI and Brent forecasts for 2017 at USD 52/bbl and USD 55/bbl,respectively.

　　We reason that a modeled deficit in 2018 should first require prices to riseto the US tight oil incentive cost of USD 50-55 in 2017, before therequirement for further supply growth beyond 2018 may raise pricesfurther to price in offshore developments.

　　Deficit markets are typically accompanied by backwardated forwardcurves which implies that spot prices may eventually rise above incentivecosts.

　　None of this detracts from the urgency of the surplus this year, however,which we model at +650 kb/d, up from +450 kb/d on the basis of an earlierIran return-to-market on the back of Implementation Day on 16 January,and weaker US crude oil demand which we revise lower to unchanged yoyas January data comes in weak.

　　Although we do not expect US crude inventories to reach capacity, risingUS inventories and high US crude imports may heighten downsidepressures to push prices closer to marginal cash costs of USD 7-17/bbl forUS tight oil. With few plausible scenarios for a strong price recovery in theshort term, we lower our Q1-2016 price forecasts to USD 33/bbl for WTIand Brent.

　　We note that the 2016 surplus measures favorably against a 1.2 mmb/dsurplus last year, and represents a halfway point towards a 2017 marketwhich we model at a +160 kb/d surplus.

　　We see downside risks stemming from a lower demand growth outlookthis year in the event that US product demand remains extremely weak,and from the possibility that equity market declines feed through intolower consumer confidence and spending. Upside risks may arise fromeither a weak or unsustained rise in Iranian exports, which may then leadto OPEC production in 2017 below our assumption of 32.4 mmb/d(excluding Indonesia).