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With Brent and WTI prices seemingly range bound between $50-$60 and U.S. oil inventories remaining stubbornly high, it would seem likely that OPEC will extend or deepen its historic production cut announced in December 2016. Notably, for global petroleum inventories to fall by some 300 million barrels to the five-year average, producing countries must comply 100% with the supply accord and growth in demand for crude will have to remain healthy. OPEC ministers have previously stated that oil stocks need to fall near to their five-year average for the group to say markets are becoming balanced. Recent data from the IEA showed that global petroleum inventories at the end of December 2016 had edged down to below 3 billion barrels, but were 286 million barrels above the five-year average.
The real question for market watchers is what level of compliance will OPEC members actually achieve and by how much will global inventories fall? For that, we will have to wait and see. Because of the time needed to obtain accurate inventory data, the extent of the drawdown will not yet be clear when OPEC members meet in May 2017. This would suggest that OPEC members will likely be inclined to extend the production cuts by an additional six months to ensure that the global supply glut in oil does not persist. Further, should the majority of OPEC members show compliance with the agreement by May, this would indicate effective cooperation among cartel members and will make it easier to extend the agreement. Finally, the elephant in the room that could ultimately lead to a production cut extension is the upcoming Saudi Aramco IPO (potentially worth $2 trillion). Recent reports from Saudi Arabia suggest that the kingdom is considering delaying the IPO until late-2018. Ultimately, the longer it takes Saudi Aramco to go public, the longer Saudia Arabia (OPEC's largest producer) has to support higher oil prices. Many market watchers believe that Saudi Arabia is looking for Brent prices to be north of $70 a barrel by the time Saudi Aramco launches its historic IPO.
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Last week, the EIA reported that the 4-week average of gasoline supplied (or implied gasoline demand) in the U.S. was 8.2 million bbl/d, the lowest since February 2012. Specifically, the data suggests that U.S. gasoline demand fell by 460,000 bbl/d or 5.2% in January year-over-year (a decline only previously seen during recessions). This data would suggest that U.S. gasoline demand (which accounts for 10% of global consumption) has declined significantly on a year-over-year basis. If the EIA's data is correct, U.S. refiners would now be facing the prospects of weakening gasoline demand for the first time in five years. This would truly be a troubling development for the oil markets especially considering that gasoline use has grown every year since 2012, despite fears that demand has topped out amid the growth of fuel efficient cars, urbanization and an aging population. Coupled with what appears to be weakening U.S. gasoline demand, the EIA today reported a significant build in U.S. crude inventories of 13.8 million barrels (above the upper limit for the season). Slightly offsetting the crude build was a decline of 900,000 barrels in gasoline inventories.
So, given that all other economic indicators in the U.S. are calmly flashing green, is the EIA data on gasoline demand truly accurate and is a recession quietly gripping over the U.S. Interestingly, Goldman Sachs weighed in on the EIA's findings suggesting that the EIA demand data is simply incorrect. Goldman went on to reiterate its outlook for strong global demand growth in 2017 and views the recent U.S. gasoline builds as reflective of transient regional shifts in gasoline supply instead. Overall, market watchers should be careful on solely relying on weekly demand numbers, as these numbers can be erratic and inconsistent week-to-week. On the question of gasoline demand, it is clear that the market will need a few more months of data to fully determine whether the U.S. is actually slipping into a recession. It is important to note that most economists don't see a recession in the U.S., and several energy analysts recently noted that demand picked back up this past week to a more normalized level. Based on these assertions, it would appear that the dramatic year-over-year drop in the EIA's gasoline demand data for January is likely an anomaly that will correct itself going forward. OPEC production cut uncertainty combined with the threat of a potential U.S. border tax created panic among Canadian energy investors in the month of January. This panic has led to a roughly 10%-15% drop in the Canadian energy complex, creating a compelling buying opportunity for investors. Firstly, OPEC stated this week that members in January have delivered on about 82% of their deal to lower supply by 1.16 million bbl/d (suggesting that initial OPEC compliance with the pledged reduction has been relatively high). Further, Russia stated that it has reduced production by 100,000 bbl/d and is on track to meet its targeted reduction of 300,000 bbl/d. These initial numbers would suggest that compliance risk around planned OPEC cuts is quite low.
Secondly, investors remain concerned about a potential U.S. border tax, which could put the Canadian energy industry at a significant disadvantage to its U.S. counterparts (i.e. U.S. producers would have a 20%-25% inflated sales price). This border tax coming to fruition appears unlikely as implementation would significantly increase gasoline prices for U.S. consumers (anywhere from $300-$400 per household per year in additional gasoline expenditures). Further, historical data suggests that a strong inverse correlation exists between gasoline prices and U.S. Presidential approval ratings. Accordingly, it would seem unlikely that the White House would want to risk further impacting its already low approval ratings. Finally, the U.S. needs Canadian oil to help it achieve its goal of North American energy security and would likely not risk this outcome with a punitive tax on Canadian oil. Overall, the current fears in the market place that have impacted Canadian energy stocks in January would appear to be unwarranted. Once additional clarity is provided on these issues, it is very likely that valuations for Canadian Energy stocks will once again continue on their upward trajectory. |
Jason SawatzkyA Canadian Energy expert Archives
October 2020
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