OMR: Building on success
12 October 2017
Over the last few months, questions lingered about whether producers were seriously committed to their agreement to cut output and balance the market. While there may still be doubts about some of them, the market heavyweights have once again walked into the ring. A few weeks ahead of the next OPEC meeting, Saudi Arabia and Russia have strengthened their relationship with a high level summit, and a series of investment agreements accompanied by statements suggesting that the current oil output cuts might be tightened. Of course, we must wait and see what happens. But there is little doubt that leading producers have re-committed to do whatever it takes to underpin the market and to support the long process of re-balancing.
The backdrop to these high-level manoeuvers is the recent volatility we have seen in the Brent crude market, with prices coming close to the symbolic level of $60/bbl before retreating to $57/bbl. Uncertainty with some suppliers (Libya, Venezuela, Iran and northern Iraq) and signs of possibly slower than expected growth in US shale production, coupled with strong oil demand, provided upward momentum to the market. Producers looking for higher prices were on the verge of declaring victory. The number of net long positions held by money managers in Brent futures rose to their highest-ever level through September. However, more recently, enthusiasm has peaked and profit taking has set in. For WTI, the mini bull run was more limited because logistical constraints saw crude oil stocks increase at Cushing, causing the discount to Brent to blow out to nearly $7/bbl from only $2/bbl in June. Even the huge increase in US crude oil exports in late September to a record level of close to 2mb/d only increased the value of WTI versus Brent by about 95 cents/bbl. Markets have a tendency to over-shoot during headline-heavy periods, which is probably what we saw with Brent.
Meanwhile, detailed analysis of the global balance shows that in 2017 each quarter will show a deficit, other than a tiny build in 1Q17, and, for the year as a whole, stocks will fall by 0.3 mb/d. This assumes OPEC crude oil production remaining at 32.7 mb/d. Data is of course subject to revision, but we can now clearly see a major reduction in floating storage, oil in transit, and stocks held in some independent areas. In the OECD, the five-year average stock overhang is now down to 170 mb from 318 mb at the end of January and stocks have fallen in months when they normally increase, offsetting net builds in China. In the case of China, there is always a margin for error in data that is often derived rather than reported, but crude imports have fallen every month since June and the implied net build for China’s stocks in September was relatively small at 100 kb/d.
Looking into 2018, we see that three quarters out of four will be roughly balanced – again using an assumption of unchanged OPEC production, and based on normal weather conditions. However, our current numbers for 1Q18 imply a stock build of up to 0.8mb/d. Taking 2018 as a whole, oil demand and non-OPEC production will grow by roughly the same volume and it is this current outlook that might act as the ceiling for aspirations of higher oil prices. Leading oil producers will have looked at their market balances and probably drawn the same conclusion. The next few weeks ahead of the producers’ meeting in Vienna on 30 November will be crucial in shaping their decision on output. A lot has been achieved towards stabilising the market, but to build on this success in 2018 will require continued discipline.