OMR: Taking Stock
15 March 2017
The price of oil has been stuck in a narrow range since the conclusion in mid-December of the OPEC/non-OPEC production accords. The thinking was that a floor had been put under prices, at an unspoken level of $50/bbl, so producers were probably comforted by the fact that Brent crude oil barely moved much below or above $55/bbl. Until 7 March, that is. The sudden move downwards saw prices return to almost exactly the same level as on 30 November – just below $52/bbl for Brent - when the OPEC deal was announced. The main trigger for the recent fall was mainly US-centred, caused by yet another build in crude oil stocks reported in preliminary weekly data from the Energy Information Administration (EIA).
The stock build should not, however, be much of a surprise. Prior to the Vienna agreement production from OPEC countries was increasing relentlessly; from September to November inclusive output surged by an estimated 580 kb/d. Export volumes are still appearing in storage around the world and, as part of this, US stocks are building. The US is seeing a triple surge in supply: rising imports (exports are also growing), rising domestic production and falling refinery utilisation. For crude imports, volumes so far this year are close to 400 kb/d higher than a year ago; US crude oil production has increased by 400 kb/d since September; and refinery runs fell from 17 mb/d at the start of the year to only 15.5 mb/d at the beginning of March. It is hardly surprising, therefore, that we have a big backlog of unabsorbed crude oil.
Broadening the picture, new data for total OECD oil stocks confirms the legacy of higher production last year. Stocks started falling in August from record high levels and by end-December were 120 mb lower, an average decline of nearly 800 kb/d. However, in January we saw an abrupt about turn with OECD stocks increasing by 48 mb (1.5 mb/d) and preliminary data for February suggests they have fallen back again only modestly.
So, the market is still dealing with a vast amount of past supply, which will take time to work its way through the system. Meanwhile, demand growth has not provided any further encouragement after three consecutive months when we upgraded our estimates. Our annual outlook for 2017 remains unchanged with demand expected to grow by a healthy 1.4 mb/d, although within the annual average we revised down our 1Q17 growth forecast by 0.3 mb/d and revised up our 4Q17 forecast by the same amount.
Beyond the nervousness about this legacy supply and concerns about rising production today from some non-OPEC countries; the implementation of the OPEC production agreement appears in February to have maintained the solid start seen in January. For the first two months of the deal the compliance rate averaged 98%, although the figure is very heavily influenced by Saudi Arabia whose rate was considerably higher at 135%. For the eleven non-OPEC countries that are pledged to cut 558 kb/d of production, there is, as yet, far less data visibility. Russia, which makes up more than half the total non-OPEC reduction, has consistently said that its cut would be gradual, and this is also the case for some other countries. Provisionally, we estimate that the non-OPEC countries have cut production by 37% of their commitment in the first two months of the year.
The market needs time for the full impact of the big supply cuts under the output reduction agreements to be felt. We do not predict OPEC production per se, but if current production levels were maintained to June when the output deal expires, there is an implied market deficit of 0.5 mb/d for 1H17, assuming, of course, nothing changes elsewhere in supply and demand. For those looking for a re-balancing of the oil market, the message is that they should be patient, and hold their nerve. In the meantime, the volatility that suddenly broke out last week will probably recur, as the IEA has regularly warned.