Oil bucks OPEC plans
Recently, crude price projections for several years ahead were based on the assumption that shortages of supply – as some conventional upstream projects are put on hold – will be significant and will likely push up prices already in 2018. Uncertainty was related only to the scale of those shortages and their upward pressure on prices. Such outlook for oil prices was presented in late 2016 by the International Energy Agency. I also think that the idea behind the OPEC−Russia deal to cut oil production was to sustain oil prices until such market pressure develops. Our own price scenarios from the end of 2016 envisaged an upward pressure on oil prices.
However, developments on the global crude oil market in Q2 2017 put a question mark over those earlier expectations. We indicated the possibility that expectations could change in our May post. Further information about the oil market supported the proposition that no upward price pressure was in the offing and that this situation could continue beyond 2018. The key reason was the soaring tight oil production in the US. In early 2017, its expected increase was estimated at 0.4 mbd, while the latest estimates are closer to 1.0 mbd. The surprisingly significant growth in supply has not been caused by rising crude prices though, but by striking gains in production efficiency. What is more, expectations concerning production in the US are increasingly high. For instance, in late June IHS Markit revised its forecast of oil production in 2018 (January−December) to 550,000 bd, from 300,000 bd forecast in May. The oil price growth in anticipation of the agreement to cut production by OPEC and in the few months following the decision made a release of some of the US crude oil stocks profitable, with the effect of increasing supply. This has been, and most probably will continue to be, supported by increased production in Libya and Nigeria (the OPEC countries exempted from the production cut agreement) and other crude-exporting countries, as they will be forced to increase sales to maintain revenue streams in a low price environment.
Excess supply of crude oil relative to decently growing demand is currently expected by the market over the next four to six quarters. An argument in support is the oil price response to the extension of the production cut deal between OPEC and Russia. The price hikes were only temporary and were halted on May 25th, when the deal was announced. The market believes that the overall production cut by OPEC will not suffice to offset the increased supply from non-OPEC countries.
The perceived excess supply also explains the price resilience to the risk of supply disruptions. Five years ago, any geopolitical turmoil in the Middle East or in the Persian Gulf region drove prices up. The Arab Spring added nearly USD 20 (20%) in risk premium to the price of oil. At present, neither the war in Syria (going through its successive phases) nor the blockade of Qatar have any visible impact on the price.
Let’s have a look at the figures. In late June, IHS Markit estimated that in 2017 global demand for oil and liquid fuels will grow by 1.5 mbd, up 0.1 mbd year on year, while total production volume will grow at a slower pace, by 1.1 mbd. OPEC countries will reduce output by 0.1 mbd. On the other hand, non-OPEC countries, mainly the US and Canada, will increase production by 0.7 mbd. In 2017, the final factor shaping the supply and demand balance will be a reduction of oil and liquid fuel stocks. By contrast, the situation will reverse in 2018. An increase in supply, estimated at 2.3 mbd, will again exceed quite a considerable increase in demand, of 1.7 mbd. The oversupply will replenish oil and liquid fuel stocks, and will also serve as a buffer filling any potential supply gap that could result from abandoned upstream projects, the scale of which is yet unknown. It is therefore plausible to conclude that the average price of crude oil in 2018 will not be higher than in 2017, or may even drop, unless the OPEC cartel and Russia surprise the market by a sufficiently deep production cut, which today is believed highly unlikely.