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With OPEC and non-OPEC members unable to reach a deal over the weekend to freeze oil production, a few positive conclusions can be drawn. Most notably, the lack of a Doha deal will allow the rebalancing process of supply and demand to continue to its natural conclusion. Specifically, market fundamentals would suggest that the global oil market is already heading to a natural equilibrium. On the demand side, recent data from China suggests that a dramatic build-up in the countries strategic petroleum reserve and surging demand for imported crude oil are likely to transform the global energy markets in 2016 (regardless of any production freeze agreed to by OPEC). It is estimated that China will import an average of 8 million b/d of oil this year, a significant jump from 6.7 million b/d last year. This is arguably enough to soak up a large portion of the excess supply currently flooding global markets. Also, combined with increasing demand from China is fast rising oil demand in India. On the supply side, it has been recently estimated that roughly $400 billion in oil and gas projects have been shelved since the onset of the commodity slump (a significant number of depleting fields will not be replaced). Accordingly, a reduction in non-OPEC supply is likely to be in the range of 0.7-1.0 million b/d in 2016. Ultimately, a deal in Doha would have delayed the global oil price recovery with a self-defeating rally. Oil prices would have likely rallied to above $45 a barrel, incentivizing producers to quickly ramp back up production. Allowing for a natural rebalancing of the global oil markets is the best case scenario for oil prices longer term.
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In its most recent World Oil Market Report, the IEA noted that the global oil market is set to move close to balance in the second half of this year. Regarding global oil demand, the IEA still expects 2016 global oil demand to grow by 1.2 mb/d. Interestingly, India is expected to replace China as the main engine of global demand growth. Specifically, revised data for late 2015 and early data for 2016 shows year-on-year growth of roughly 8%. For 2016 as a whole, India will see growth of around 300 kb/d - the strongest ever volume increase. On the supply side, the IEA continues to forecast a fall in non-OPEC supply in 2016 of 700 kb/d (bolstered by the slide in production of light, tight, oil in the U.S.). Further, within the group of non-OPEC producers, there appears to be only a few areas of growth with only a handful of countries likely to increase production this year. Regarding Iran, it looks like the countries return to the market is playing out at a more measured than some expected (Iranian oil production in March was ~400 kb/d higher than at the start of the year). Overall, the IEA notes that based on a conservative scenario for OPEC crude oil production of 32.8 mb/d in Q2/16 and 33.0 mb/d in both Q3 and Q4, the surplus of 1.5 mb/d built in H1/16 should fall to 0.2 mb/d in both Q3 and Q4. Based on the IEA's assumption, it looks like $50-$60 WTI by year-end could be a real possibility.
With the recent recovery in WTI to $40 Bbl (from the lows of $27 Bbl), a few Analysts are now calling for $85 WTI by year-end. So, what exactly is driving this extremely bullish view on WTI and is it possible? The argument for $85 oil by year-end hinges on two factors; one is demand growth and the other is a contraction of non-OPEC supply (the first time this has happened in about eight years). Specifically, increased demand at a time of shrinking supply could boost prices. Analysts are pointing to a few key near-term trends: 1) the IEA could be underestimating oil consumption in the non-OECD countries 2) oil markets could be tighter than everyone thinks (i.e. oil inventories could be drawn down contra-seasonally) and 3) significant reductions to oil and gas capex and reduced upstream activity will significantly affect future production growth. Although $85 WTI by year-end may seem optimistic, one could make the case for $50-$60 WTI based on the above near-term trends. With last weeks surprise draw in U.S. crude inventories (draw of 4.94 million barrels), we are already seeing physical evidence of a contraction in non-OPEC supply.
The EIA reported today that U.S. crude stockpiles dropped from the highest level in more than eight decades as refineries bolstered operating rates. Specifically, crude inventories decreased 4.94 million barrels last week as refineries processed the most crude in three months as production and imports declined. Notably, refinery utilization is now picking up and production is down, which could signal the end of large builds in crude as refinery utilization grows. Refineries bolstered operating rates by 1% to 91.4% of capacity. Of note, U.S. refiners typically increase utilization in April as they finish maintenance before the summer peak driving season. On the back of today's EIA report, West Texas Intermediate for May delivery increased by over 5%. The key takeaway from this report is that most Analysts surveyed were anticipating a new record build in crude this week. With the surprise large reduction in inventories, this will likely signal to market participants that WTI has likely hit a floor. Further, this report should force the crude bears to rethink their bearish balances for Q2/16. Also contributing to the positive momentum in crude today is hopes for an agreement among major OPEC oil producers to freeze output. Notably, Kuwait's OPEC governor said this week that a meeting of oil-producing countries in Doha on April 17 will deliver an agreement to hold output at January highs despite Iran pouring cold water on the plan.
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Jason SawatzkyA Canadian Energy expert Archives
October 2020
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