OMR: Is seventy plenty?

19 January 2018

A volatile year should be expected for oil, with geopolitical uncertainties and ever-dynamic prospects for US shale (Photograph: Getty Images)

The price of Brent crude oil closed earlier this week above $70/bbl for the first time since 2 December 2014 (shortly after OPEC’s “market share” ministerial meeting) and money managers have placed record bets on the recent upward momentum continuing. The factors contributing to this burst of optimism by investors include; the possible unravelling of the Iran nuclear deal and recent demonstrations in the country, disruption to the industry in Libya, and the closure of the Forties pipeline system. Although these factors might have faded somewhat, there are others at work. The general perception that the market has been tightening is clearly the overriding factor and, within this overall picture, there is mounting concern about Venezuela’s production.

Taking Venezuela first, production has been sliding for a long time – it is now about half the level inherited by President Chavez in 1999 – and in December output was 490 kb/d lower than a year ago, having fallen to 1.61 mb/d. It is reasonable to assume that the decline will continue but we cannot know at what rate. If output and exports sink further other producers with the flexibility to deliver oil similar in quality to Venezuela’s shipments to the US and elsewhere, including China, might decide to step in with more barrels of their own.

The oil market is clearly tightening; in the three consecutive quarters 2Q17-4Q17 OECD crude stocks fell by an average of 630 kb/d; such a threesome has happened rarely in modern history: examples include 1999 (prices doubled), 2009 (prices increased by nearly $20/bbl), and 2013 (prices increased by $6/bbl). Since the nadir for Brent crude in June when the price was $45/bbl, the 2017 OECD crude draws have coincided with a price increase for Brent of nearly $25/bbl.

A judgement as to whether the recent price strength is sustainable must take into account the rapid growth in global oil supply seen recently and which will continue through 2018. Short-cycle production from the US is reacting to rising prices and in this Report we have raised our forecast for crude oil growth there in 2018 from 870 kb/d to 1.1 mb/d. It is possible that very soon US crude production could overtake that of Saudi Arabia and also rival Russia’s. After adding in barrels from Brazil, Canada and other growth countries, and allowing for falls in Mexico, China and elsewhere, total non-OPEC production will increase by 1.7 mb/d. This represents, after the downturn in 2016 and the steady recovery in 2017, a return to the heady days of 2013-2015 when US-led growth averaged 1.9 mb/d.

This projected big increase in non-OPEC production needs to be set against our current forecast for oil demand. For 2018, we see growth of 1.3 mb/d, a conservative number that acknowledges the current perception of healthy global economic activity, but also takes into account the fact that benchmark crude oil prices have increased by 55% since June and this can dampen oil demand growth to some extent. The uncertainty surrounding Venezuela is such that our regular practice of showing a market scenario chart that assumes steady OPEC production must be treated with caution. If OPEC countries plus their non-OPEC supporters maintain compliance then the market is likely to balance for the year as a whole with the first half in a modest surplus and the second half in a modest deficit.

This scenario, or something similar to it, presumably lies behind the assumption by forecasters surveyed by Reuters that Brent will trade in a $60-$70/bbl range in 2018. Whether or not the recent price rise has run out of steam and seventy really is plenty remains to be seen. However, such are the geopolitical uncertainties and the ever-dynamic prospects for US shale that we should expect a volatile year.