Commentary written in August 17 for Newsbase, predicting the subsequent crude price rise:
Low prices finally producing signs of crude market stabilization
It has been a while, but the low oil price and OPEC constraint may finally be influencing the fundamentals of supply and demand sufficiently to erode stocks and ensure market rebalancing, leading to some price recovery and greater stability in crude markets. However, the upside isn’t expected to amount to much, and the days of $100/bl crude are still some way off.
The last few weeks have seen Brent rise to a five month high of over $55/barrel from below $45/bl in June, and US benchmark WTI has experienced similar strength. Developed nation (OECD) crude stocks are now back to below 200 million barrels above their 5-year average, and the long period of relatively low prices does seem to be stimulating demand, with many observers noting higher than expected totals so far this year, and making more bullish predictions for next year. At the same time, OPEC’s efforts at restraining supply are having a cumulative effect and cuts in upstream investment are also steadily adding up – which is affecting both non-OPEC legacy fields and future output.
This higher demand and lower supply should continue to slowly draw down stocks and maintain upward pressure on prices. “Based on recent bets made by investors, expectations are that markets are tightening and that prices will rise, albeit very modestly,” the International Energy Agency (IEA) said last week, referring to a rise in speculative net long positions in Brent futures and options.
In its latest outlook released last week, the IEA said global consumption was up 2.3 million b/d in the second quarter, the highest quarterly year-on-year rise since mid-2015. For 2017 as a whole, the IEA revised its growth estimate 100,000b/d upwards to 1.6 mb/d, while OPEC has raised forecasts of demand for its oil in 2018. The IEA said OECD demand growth continues to be stronger than expected, particularly in Europe and the US. The news presents a challenge to the EU in particular, where oil demand had been falling and was expected to keep falling indefinitely in order to meet climate change and clean air targets.
The US Energy Information Agency (EIA) also expects demand to rise in its latest outlook, led by OECD countries, reflecting the latest actual data and reversing the decline seen for several years up to 2014 due to high prices. What’s more unexpected is that, after flattening in the 2020s, the EIA then shows a rising trend again after 2030*. “As oil prices rise, energy consumers are expected to turn to more energy-efficient technologies and switch away from liquid fuels where possible,” said the EIA, clearly signalling an anticipated price rise in oil prices over the next decade. But beyond that lower prices might again stimulate demand.
On the supply side, OPEC’s crude output fell in August for the first time in five months on renewed disruption to Libyan supply, with the cartel’s production down by 210,000 b/d to 32.67 million b/d. Also in August, the 12 members of OPEC with supply restrictions raised their compliance to 82% from 75% in July, while the ten non-OPEC countries cooperating with production cuts achieved more than 100% compliance for the first time. The OPEC 12’s compliance for the year so far has been 86%, according to the IEA, which is high.
Looking at the wider global oil output, levels fell by 720,000 b/d in August due to unplanned outages and scheduled maintenance in Russia, Kazakhstan, Azerbaijan, Mexico, and the North Sea, as well as the lower OPEC total. It was the first fall in global production in four months, leaving output at 97.7 mb/d – up 1.2 mb/d on the year due to high non-OPEC growth. That growth is expected to moderate from now on, and OPEC says the market is tightening, as its deal with non-OPEC states – along with the other falls – slowly absorb the supply glut that led OECD stocks to rise more than 400 million barrels above the 5-year average.
And, while earlier this year, it was assumed that any rise in prices would spark further increases in shale output, there are now growing concerns over the financial model used by shale drillers, which may dampen their response to higher prices. Last week US onshore rig counts fell to the lowest level since June, and analysts will be watching closely how drillers react to the latest market strength.
Existing onshore conventional non-OPEC production has declined significantly since the price fall, due to a lack of new brownfield or EOR project start-ups. And further legacy field decline rates could mean non-OPEC production losing 1 million b/d per year over the next five years if prices stay low, while new project capex cuts will also mean less new volume coming onstream than had been expected.
As a result of the output declines and stronger demand, global oil stocks are beginning to rebalance, according to the IEA. “OECD commercial stocks were unchanged in July at 3.016 billion barrels, when they normally increase,” the IEA said, which allowed the global surplus of crude stocks over the five-year average to stabilize around 190 million barrels.
Anecdotal evidence also suggests stock draws, with reports from the North Sea indicating that the volume of Brent price benchmark crude being held in floating storage has declined sharply since mid-August. Prompt markets are beginning to tighten up and gaining a premium to forward prices, which is boosting the incentive to reduce stocks or maintain floating storage.
Global product stocks were only 35 million barrels above the five-year average in August and with 3Q17 IEA refinery throughput forecasts down by 700,000 b/d, due to weather disruption, there could be undersupply and further product stock-draws in Q3. The IEA then forecasts higher margins and a throughput rebound to a record 80.9 mb/d in 4Q17, as refiners respond to higher margins in the tightening product markets.
The impact of price on the demand side is already apparent, but much of the effect on supply will not be felt for some time to come – with the impact adding up as each year passes, gradually ratcheting up pressure on prices, especially as stocks come down further from their historic highs. And if this week’s news from UK scientists that global warming may be less severe than first thought is also considered, there is certainly still plenty of potential for further upside in the global crude oil markets.
*The U.S. Energy Information Administration’s latest International Energy Outlook 2017 (IEO2017). https://www.eia.gov/outlooks/ieo/pdf/0484(2017).pdf (P.19)