Elizabeth Belugina, the Head of Analytics Department at FBS
Despite renewable energy sources, oil is still the world’s key commodity. In the first half of the year, Brent futures traded between $58 and $44.35 a barrel, while WTI fluctuated between $55 and $42. The overall bias was to the downside, although there were a number of rebounds.
Let’s see what factors are having an impact on oil dynamics and try to outline this market’s prospects for the next several months.
The main fighter with the market’s oversupply is the Organization of the Petroleum Exporting Countries (OPEC). OPEC and some non-OPEC producers agreed to cut oil production by 1.8M barrels a day since January 2017. In May, the cuts were extended until the end of the first quarter of 2018.
However, the market has serious doubts that the nations are really committed to supply cuts. The longer the prices remain low, the harder it is for the members to respect their pledges. Indeed, so far compliance among OPEC members has been worsening. According to the International Energy Agency (IEA), it fell in June to 78%, which is the minimal level since the start of the deal. The main breakers of the agreement are Libya and Nigeria, but even the bloc’s de facto leader Saudi Arabia now puts in limiting the production less effort than before. Estimates show that there was no improvement in July.According to a Reuters survey, the bloc’s oil output rose last month by 90K barrels a day to 2017 high.
OPEC members do try to amend the situation, at least verbally. Saudi Arabia pledged to further cut its crude exports from July, while Nigeria said it was willing to stop raising its production once it reaches 1.8M barrels of crude oil production daily. However, Ecuador stepped back from the deal and announced that it plans to gradually increase output. Even if Ecuador’s actions have a small impact on the overall supply, the market’s sentiment will likely suffer.
It now increasingly looks like the existing steps of OPEC are not enough to push the prices above $50 a barrel and make them settle there. Will the cartel keep on knowing that there are other players who will benefit from their supply cuts?
The beneficiaries from the OPEC-led production cuts are none other than the US shale oil producers. The IEA predicts a 53% upswing in shale investments this year and the United States will account for the most of it. The US Energy Information Administration lifted its 2017 US output forecast in May to an average of 9.31M barrels a day.In June, it raised 2018 production forecast as well.
One of the biggest advantages of the US oil industry is that it is extremely flexible. American drillers adapted to lower oil prices by reducing drilling costs and increasing production efficiency. The number of rigs operating in US fields has more than doubled in the past year. US producers are enjoying the higher prices for future delivery, which they managed to lock in during the temporary price boost caused by OPEC. Naturally their ability to remain in business has its limits. Estimates show that if prices fall towards $40 a barrel, shale production will become loss making and curtail. On the flip-side, once the prices recover, drillers will be as quick to reopen production.
US supply comprises production and inventories. As for the latter, the latest trend is for the US oil stockpiles to contract: this is the first year since at least 2000 that the US oil inventories have fallen between the end of February and the start of July. Although on the surface this may look bullish for oil, deeper analysis shows that this decline happened because the US significantly increased oil exports. Global oil inventories are as big as they have been at the start of the year, and this doesn’t help crude oil quotes.
When we talk about the oil market, the consumer side of things is equally important.There are views that stronger global economic growth will push up oil prices in the second half of 2017. In addition, oil consumption tends to be always higher at the end of the year.
To be fair, oil may enjoy seasonally higher demand in the current quarter. Domestic consumption in the Gulf nations rose as domestic buyers need fuel for power generators during the summer. Oil demand in the United States is also on the upswing – it a peak of the driving season, although demand for gasoline is falling behind the demand for volatile “other oil products”, that may be a worrying sign.
At the same time, demand in key Asian crude importers is faltering.China – one of the world’s main oil refiners – doesn’t seem to be a very eager oil’s buyer. Chinese state refiner Sinopec has been reducing its oil refining output by around 240K barrels a day between June and August due to weaker fuel demand and rough competition with private independent local refiners. India and Japan also have some domestic issues which are putting a break on their demand. In particular, Indian demand was hit by the recent demonetization, while in Japan the reasons for lower demand are more profound and include aging population and increasing reliance on alternative fuels.
There’s a great variety in predictions of future oil prices. Still, taking into account everything listed above, it becomes clear that substantial fundamental drivers for a rally in the oil market are absent. OPEC’s cuts don’t take much out of the market, and with the course of time, it will be harder for the producers to sustain discipline in adherence to their pledge.
Of course, there are contingencies that may derail the outlook for the oil market. Factors which are hard to predict like tensions in the Middle East, turmoil in Venezuela and instability in Libya can reduce supply. At the same time, higher prices in July create favorable conditions for the US producers. Their presence at the market creates a ceiling for the oil prices. In these circumstances, the impact of any improvement in demand for oil will likely be negated by higher supply. All in all, it is hard to see either supply or demand considerably outweighing one another in the coming months.
As a result, we expect oil to fluctuate around $50 a barrel. It seems that the market has found a medium-term balance around this level. The overall bias may turn bullish by the end of the year, although only slightly.