Recent Build in US Crude Oil Inventories is Bearish on the Surface, But There is a Silver Lining....
This past week, the US Energy Information Administration (EIA) reported that US crude oil inventories rose by 3-million-barrels for the week of February 23rd. Analysts had expected the EIA to report a 1.2-million-barrel build in crude oil inventories, so the actual figure was viewed as bearish. Further, Gasoline stockpiles were also up, by 2.5 million barrels vs. a 300,000-barrel build in the previous week. While the recent build in inventories is bearish on the surface, one has to look at the bigger picture to really understand the current US inventory situation. Overall, since hitting a record high of 540 million barrels in 2016, US storage levels have steadily declined to around 420 million barrels (just slightly above the 5-year average). Interestingly, the last time storage levels were at the 5-year average in late November 2014, the WTI price was around $72.50 per barrel (vs. the current price of $61.25 per barrel).
Looking forward, as we head into the busy US summer driving season, crude inventories typically decline at the beginning of June through mid- to late-July (before beginning to increase again in August). Also, with OPEC (and Russia) likely maintaining its production cuts through 2018 and global demand for oil expected to add 1.7-2.0 million bpd this year over 2017, there is a clear path for US inventories to drop well below the 5-year average. Should inventories drop below the 5-year average, this would be a very bullish sign for gasoline and oil prices. The one fly in the ointment is increasing US oil production (currently at 10.27 million bpd), however, it is our belief that the rate of increase will not be enough to offset the OPEC cuts and rising global oil demand. Therefore, should US crude oil inventories drop below the 5-years average, we believe a $70-$80 WTI price is very likely later this year.
During the past few months, oil prices have been grinding higher and higher, which is spurring some forecasters to predict oil could hit $80 a barrel by the end of 2018. A number of factors have combined to positively impact oil prices including OPEC and Non-OPEC production cuts, declining production from Venezuela, a weakening US dollar and US shale production loosing a bit of steam. Undoubtedly, the largest contributing factor to oil's recent rise has been OPEC and Non-OPEC nations maintaining their production cuts through 2018. The greater impetus by Saudi Arabia (the largest OPEC producer) to maintain higher oil prices ahead of the widely-anticipated initial public offering of Saudi Aramco should support oil prices through 2018. Further, mix in the potential for geopolitical crises around the world and oil prices could very easily move into the $70 to $80 range. For example, a re-imposing of U.S. sanctions on Iran, the third-biggest OPEC producer, is likely to dislocate at least 500,000 barrels of the Middle Eastern nation's oil exports. Any supply disruptions in Iraq, Libya, Nigeria and Venezuela could see global oil supply drop by more than 3 million bbl/d in 2018. Overall, with global supplies already so tight, any unexpected disruption could cause prices to surge.
Recall, oil prices last hit $80 per barrel in November 2014. Both WTI and Brent collapsed from above $100 per barrel in June 2014 to around $30 a barrel in January 2016 due to weak demand, a strong US dollar and booming U.S. shale production. Considering all of the factors that are positively impacting oil prices today, 2018 might finally be the year for the return of commodities.
As we close out 2017, market watchers now focus their attention on what will drive oil prices in 2018. First, and most importantly, will be weather OPEC sticks to its recently extended production cuts. Notably, OPEC and its allies outside the group agreed to maintain oil production cuts until the end of 2018, extending their campaign to wrest back control of the global market from America’s Shale Industry. Subsequently, Brent crude surged into a bullish, backwardated structure towards year-end as OPEC-led output cuts tightened global supplies. OPEC members plan to review the production limits at its June 2018 meeting.
Secondly, the US Shale Industry's response to higher oil prices in 2018 will have a significant impact on whether oil prices will have a ceiling. With shale growth driving forecasts of record U.S. supply in 2018, this could push out the balancing of global supply and demand until late 2018. Notably, the International Energy Agency (IEA) recently stated that increased US shale production could lead to an oil surplus of 200,000 barrels a day in the first half of 2018 before the market sees a deficit of 200,000 b/d later next year.
Finally, geopolitical risks are always a factor, which could impact oil prices in 2018. Specifically, geopolitical risks have flared in a host of major oil producing countries in recent months. Venezuela, Iran and Saudi Arabia top the list of countries that could see oil-related disruptions in 2018. Interestingly, recent positive developments in the oil market, most notably the OPEC cuts, have resulted in a record number of bullish bets in Brent and WTI combined heading in 2018. These bullish contracts now outstrip bearish ones by seven to one, however the types of players making these bets (speculators vs. long term) remains unknown. As oil watchers seek to plot a course through the year ahead, one thing is for certain, 2018 will likely bring more volatility and uncertainty in the global oil markets.
With a number of positive data points and sentiment now shifting, it looks like WTI is now setting up to push $60 by year-end. Notably, it is widely expected that OPEC will maintain its current production cuts at the upcoming meeting on November 30th. Further, we are now seeing signs of slowing U.S. production with this weeks large decline in the U.S. rig count (down 11 rigs w/w). Accordingly, oil prices have maintained their recent gains and are showing signs of heading even higher, causing many analysts to now consider the possibility of a $60 price floor. Further, the fact that Brent has avoided a retracement back below $60 per barrel is good news for oil bulls.
Over the next few weeks, the driving force behind the oil price narrative will be OPEC's commentary prior to the November meeting. Notably, the flurry of comments in recent weeks from OPEC officials has steadily ratcheted up expectations for what they will agree to at their upcoming meeting in Vienna. The latest report from sources at OPEC suggests that the cartel is likely set to agree to an extension through the end of 2018 rather than just for three months beyond March. OPEC members have indicated that they would like to see commercial stocks reduced further. Interestingly, some officials have even struck a more bullish tone stating that OPEC members feel that $60 (a barrel) should be the floor for oil prices next year. Finally, geopolitical tensions around the world, most notably U.S. sanctions on Venezuela (which could see the county lose an additional 240,000 bpd in output next year), should help further shore up oil prices heading into year-end.
The IEA recently released its September Oil Market Report, which noted global oil demand is increasing and global oil supply is decreasing. Notably, the IEA stated that global oil demand is set to accelerate faster than anticipated this year, promoting a revision to the agency's forecasts. Specifically, the IEA noted that oil demand grew by 2.3 million b/d, or 2.4 percent, in the second quarter of 2017, prompting the Paris-based organization to increase its growth estimate for 2017 to 1.6 mb/d, or 1.7 percent. For 2018, the IEA is predicting growth of 1.4 mb/d, or 1.4 percent (likely conservative, considering improving demand in countries such as the U.S., China and Europe). This revision marks an uptick from the IEA's August forecasts, as shifting fundamentals are enabling demand to catch up with supply. In August, the IEA has anticipated annual growth would hit 1.5 mb/d, again an increase on July's 1.4 mb/d forecast.
Regarding the supply side, global oil supplies fell in August due to both multilateral measures aimed at stemming excess stock and unplanned outages. Notably, OPEC output fell in August for the first time in five months (following turmoil in Libya disrupted flows and other member countries reduced production). OPEC compliance levels in August hit 82%, and OPEC members plan to meet towards the end of September to further improve compliance. Overall, global oil supply fell by 720,000 barrels per day in August (now approaching the 5-year average - a critical level to support higher prices). As a result, Brent oil prices rose by over 5% this past week and and crucially the market is now in backwardation (a sign that the market is tightening and perhaps firmer prices are on the way). These positive data points highlighted by the IEA suggests that the energy markets could finally be in full recovery mode, following three painful years for the industry.
Recent data points suggest that rebalancing in the global oil market is speeding up, as oil posted its best weekly gain this past week (up 8.6% to $49.71). Notably, U.S. crude and gasoline inventories fell much more steeply than expected this past week (7.2 million barrel drop) and the world's biggest oil exporter Saudi Arabia said it would further reduce oil output in August. At the OPEC meeting this past Monday in Russia, which included some non-OPEC producers, Saudi Arabia announced it would cut August exports to 6.6 million barrels a day, which would be a million less than a year earlier. Saudi Arabia, the world’s biggest crude exporter, typically rolls back shipments in the summer as domestic demand peaks, though a shipment cut of that size should notably expedite market rebalancing. Nigeria, which has been exempt from this year’s OPEC-led production-cut deal, vowed to keep daily production at no greater than 1.8 million barrels. The cartel’s latest data put the country’s output at 1.64 million.
Finally, Baker Hughes reported on Friday that the number of oil rigs operating in the U.S. rose by just 2 to a total of 766 last week. The rig count has risen fairly steadily for more than a year, but the growth has recently moderated. With signs that this year’s shale upswing may be ebbing, combined with increased OPEC compliance/measures and strong Chinese demand, oil prices could be setting up for a strong back half of the year. As the oil price funk is now into year three, amid a persistent supply glut, a speedier rebalancing in the oil markets in H2/17 will be cheered by many market watchers.
As widely expected, OPEC and its Allies announced on Thursday that it will extend its historic 1.8 million Bbl/d production cut to further reduce the global oversupply of oil and achieve a sustained price recovery. The cartel together with Russia and other non-members agreed to prolong their accord through March (giving exemption to Libya and Nigeria), but no new non-OPEC countries will be joining the pact and no option was set out to continue curbs further into 2018. Saudi Arabia's Energy Minister Al-Falih noted that the current cuts are working, adding that stockpile reductions will accelerate in Q3/17 and inventory levels will come down to the five-year average (~2.73 billion barrels) in the first quarter of 2018. Notably, Al-Falih also stated that while he expects a “healthy return” for U.S. shale, he believes this will not derail OPEC’s goals and a nine month extension will “do the trick,” Going forward, the Joint Ministerial Monitoring Committee (composed of six OPEC and non-OPEC nations) will continue watching the market and can recommend further action if needed.
Post the announcement, crude oil futures dropped by as much as 5% in New York on Thursday, before settling at $48.90. Despite the markets negative reaction, largely attributable to the lack of a sweetener in the deal or clear exit strategy, global crude oil inventories will grind lower with the new production cut extension (providing overall compliance remains strong). Accordingly, OPEC now has the wind at its back as fuel demand ramps-up ahead of the summer driving season. Further, the world uses roughly 2 million Bbl/d more oil in the second half of the year than the first half of the year, so the impact from the cuts on supply-demand will be pronounced in the second half of 2017. Overall, the combination of seasonal demand growth and the nine month extension should shrink global stockpiles and lead to a higher oil price by year end (likely in the $60 - $65 per barrel range).
In the IEA's most recent Oil Market Report, the agency stated that the oil market has essentially reached a balance and will continue to accelerate in the near term. Further, the IEA stated that the oil market was close to balance in the first quarter of the year, with average supply building by 100,000 bpd on a global level, and at 300,000 bpd for OECD members. Notably, if OPEC keeps its output at the April level, the authority estimates an inventory draw of 700,000 bpd by the end of the second quarter. Further, this number will grow if the output cut extension is agreed by everyone at the May 25th meeting. However, the agency also warned that even if OPEC extends its cuts, much work remains to be done in the second half of 2017 in order to drain stocks closer to its benchmark five-year average (roughly 2.7 Billion barrels). Also, while compliance with the agreed production cuts by OPEC and the 11 non-OPEC countries has generally been strong (roughly 96%), Libya and Nigeria (currently excluded from the cuts) could weaken the impact of the deal should production from these countries continue to show significant increases.
On the demand side, the IEA is forecasting global demand growth of 1.3 million b/d in 2017, unchanged from its April report. The agency cited a weaker-than-expected demand for oil from investors in the first three months of the year (particularly in the U.S. and India). However, Chinese demand continues to impress (compensating for most of the weakness in other countries) and is expected to be one of the main growth stories in 2017. Overall, the IEA's report concludes that even with solid demand and continued supply restraint from OPEC, absorbing the enormous glut of oil to reach the benchmark five-year average will undoubtedly be slow going.
With several multinational energy companies recently announcing their exodus from the Canadian oilsands, interests between Canada's energy patch and federal and provincial governments have now been aligned. Recent deals include Canada's largest oil and gas company Suncor (SU-T) acquiring a control position in competitor Syncrude Canada. Other major deals include the purchase of Royal Dutch Shell's oilsands assets by Canadian Natural Resources (CNQ-T), and the purchase of ConocoPhillips’ oilsands assets by Cenovus Energy (CVE-T). Notably, Canadian energy companies are now in charge of roughly 70% of oilsands production, and some have become so large they are giants of the Canadian economy. Higher Canadian ownership should lead to more efficient supply chains, better connectivity, and more motivation to work co-operatively to make the business more efficient.
Going forward, now that the Canadian oilsands is increasingly owned by Canadian companies, Canada's oil patch can now work more effectively with provincial and federal governments to try and get the proper access with the right environmental standards to market. This collaboration will effectively create a Canadian brand, but will require that the various levels of government look out for Canadian interests and enable Canadian oilsands producers to become more competitive globally (particularly when access to capital has become more difficult, as other jurisdiction such as the U.S. are more supportive around either regulation or taxation). Looking forward, the international exodus from the Canadian oil sands will likely continue, as companies like BP PLC, Chevron Corp. and Total SA evaluate their positions. As such, Canadian energy producers and government will have a chance to further align their interests and strengthen the competitiveness of this world class asset.
As Brent crude futures look to break above $55 a barrel this week, it appears that OPEC's production cuts are slowly chipping away at the global crude oil overhang. In Q1/17, data suggests that global crude stocks built by much less than they did in the first quarter of last year even though refinery maintenance globally was much heavier. Notably, Iran has sold all of the oil it had stored for years at sea and Tehran is now struggling to keep exports growing as it grapples with production constraints. Further, trading giant Vitol recently sold millions of barrels of Nigerian crude oil from storage in South Africa's Saldanha Bay with cargoes sailing for Taiwan, India, the US and Europe. Interestingly, Nigeria's new loading programs are now finding buyers at a reasonable rate – in stark contrast to the past two years, when any sales from storage put immense downward pressure on prices for newly loaded cargoes. Finally, Nordic bank SEB recently noted that global oil inventories in weekly data have dropped by 42 million barrels in the last four weeks.
Contrasting this data has been stubbornly high US crude oil inventories, which has created some confusion in the oil markets. It is important to note that rising US crude inventories are mainly a function of reduced U.S. refining activity on the one hand and U.S. crude oil imports on the other. Overall, it is going to take some time for all of the pieces of the global oil inventory picture to become clearer. That said, should OPEC decide to extend its production cuts in May, US oil inventories will likely start to draw down, as has been the case in other global oil markets including Iran and Nigeria.
A Canadian Energy expert