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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.
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OPEC's recent press release regarding its Ministerial Monitoring Committee (JMMC) meeting held in Kuwait City suggests a production cut extension in May is very likely. Specifically, the JMMC noted that "certain factors, such as low seasonal demand, refinery maintenance, and rising non-OPEC supply, have slowed down the positive impact of the production adjustments on inventory drawdowns. However, the end of the refinery maintenance season and noticeable slowdown in U.S. stock build as well as the reduction in floating storage will support the positive efforts undertaken to achieve stability in the market," Although the JMMC's language is not exactly clear, it would seem that the committee is leaning towards recommending extending the output cut. Further, numerous OPEC Energy Ministers have recently expressed their support for an extension. Specifically, Algerian Energy Minister Nouredine Bouterfa recently told reporters an extension could benefit the market.
The JMMC plans to deliberate on whether a production cut extension is needed and will submit its recommendation to participating OPEC and Non-OPEC countries before the meeting in May. Further, the committee has asked the OPEC Secretariat to review oil market conditions and come back with recommendations in April regarding an extension of the agreement. Should the cartel agree to extend its output cut, global oil inventories would further tighten and oil prices should move higher (potentially into the $55 to $60 per barrel range). IEA Report and U.S. Crude Draw Suggests the Recent Bearish Sentiment on Oil is Likely to Reverse....3/15/2017 The International Energy Agency (IEA) today reiterated its belief that OPEC cuts should create a global crude deficit in the first half of 2017. The IEA noted that global inventories rose in January for the first time in six months despite OPEC output cuts (in part because OPEC members pumped heavily before the cuts were implemented and U.S. shale producers have raised output), but said if it stuck to its production curbs the market should see a deficit of 500,000 bbl/d in H1/17. Accordingly, the market has been intently watching the weekly U.S. Energy Information Administration (EIA) figures to see if it confirms a fall in U.S. inventories. After nine consecutive weeks of inventory builds in the U.S., this week surprised the market with a crude draw of 237,000 barrels compared with analysts' expectations for an increase of 3.7 million barrels. Further, gasoline stocks fell by 3.1 million barrels, compared with analysts' expectations for a 2 million-barrel drop. Distillate stockpiles, which include diesel and heating oil, were down 4.2 million barrels, versus expectations for a 1.7 million-barrel drop.
Overall, the message from the IEA (supported by this weeks draw in crude) is that the market needs to have patience as it takes time for production restraints to filter through in the form of inventory reductions. So, as long as OPEC stays on track and non-OPEC delivers on their agreed cuts, the market will continue to balance. The question for market watchers is while such patience (suggested by the IEA) will likely benefit longer-term investors it may not be much help for money managers facing year-to-date losses on long positions (suggesting further oil price volatility in the near term is likely in the cards). At the CERAWeek energy conference in Houston this week, the International Energy Agency (IEA) noted that oil prices are set to rise sharply starting in 2020 if new energy investments are not made in 2017. Despite global oil supplies appearing adequate for the next three years (due to supply additions from growing U.S. shale and Canadian oil sands projects), in 2020 the oil markets could be in for a significant price shock. Specifically, the IEA noted that oil investments dropped sharply in both 2015 and 2016, and if that trend continues into 2017, there will be a significant problem in three years. Interestingly, the agency noted that oil investment globally was US$450 billion in 2016. The IEA is hoping to see that increase by 20% or a further US$90 billion in 2017. Regarding Canada, oil investment was estimated at $37 billion in 2016, and the Canadian Association of Petroleum Producers (CAPP) expects it to rise to $44 billion in 2017.
In terms of demand, the IEA does not see peak oil coming in either the short or medium term, as global oil demand should remain strong driven by both India and China. Notably, global oil demand grew by 2 million bbl/d in 2015, the largest year-over-year growth in five years and is expected to continue to grow at roughly 1.2 million bbl/d per year to 2022 (propelling total global oil consumption to 104 million bbl/d in 2022 from 97 million bbl/d currently). Overall, without significant investment in oil projects this year, the IEA compared the potential market dynamics in 2020 to those seen in 2008, when oil prices spiked to more than US$140 per barrel. As oil prices remain range bound between $50-$60 per barrel and so much uncertainty around whether any significant oil projects will enter the pipeline in the next few years, the possibility of a price spike in oil in the coming years seems very real. 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. 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. Post OPEC's landmark decision to cut 1.2 million bbl/d of production in December, an old problem threatens to stall the ongoing recovery in global oil prices. U.S. shale producers in the past few months have been quick to turn on the taps as oil prices continue to recover. Notably, the U.S. Energy Information Administration (EIA) projected yesterday that Permian Basin oil production will increase by 53,000 bbl/d month over month in February 2017. Further, recent acquisitions in the Permian Basin suggest that large energy producers are positioning themselves for a resurgence in oil and gas drilling in the Permian. First, Noble Energy recently announced the acquisition of Clayton Williams Energy to grow its presence in the Permian Basin. The acquisition includes 71,000 acres in the core of the Southern Delaware Basin, part of the Permian. Secondly, Exxon Mobil recently announced that is exchanging $5.6 billion in stock for approximately 275,000 acres of Fort Worth, which will double its holdings in the Permian Basin. The deal is being done with the Bass family, with the prospect of an additional $1 billion in 2020, dependent upon how the acreage performs.
Given how nimble U.S. shale producers are at responding to any increase in oil prices, OPEC will likely have to be satisfied with a long term oil price that is probably closer to $60 per barrel as opposed to $100 per barrel in days past. That said, this most recent downturn in the energy industry has allowed many oil producing countries and public oil and gas producers to trim costs and become profitable in a $60 per barrel world. Time will tell if the energy industry can keep its costs in check and thrive under this new paradigm in oil. OPEC and Non-OPEC Members Must Comply With Stated Production Cuts or Risk Lower Oil for Longer.....1/3/2017 The oil markets started 2017 with a bang on Tuesday morning with oil prices reaching an 18-month high, but quickly turned negative on dollar strength, and more importantly, news that Libyan and Russian production were up significantly in December. Specifically, Russian output in December is said to have held at record highs, while Libyan production is up to 685,000 bbl/d in recent days, more than double what it averaged in Q3 of last year. The extreme volatility in oil that has continued into the New Year, underscores the importance of OPEC and non-OPEC members sticking to agreed upon production cuts. Recall that OPEC member countries agreed to a production cut of 1.2 million bbl/d in December 2016 along with non-OPEC members (mainly Russia) agreeing to cut an additional 0.558 million bbl/d. With cuts expected to have been implemented on January 1, 2017, the market will be watching very closely for any signs of cheating by producers. Should certain countries not adhere to their new quotas, oil prices will likely remain in the $50 - $55 per barrel range for the foreseeable future.
Notably, the International Energy Agency (IEA) recently stated in their final report of 2016 that if OPEC and non-OPEC members stick to their new production quotas, the global surplus in oil will start disappearing in the first half of 2017. Prior to the agreement among producers, the IEA had suggested that the market would not re-balance until the end of 2017. Should OPEC and non-OPEC members adhere to their new production quotas, WTI will likely increase to north of $60 per barrel (positively impacting the balance sheets of all oil producing countries globally). With that said, one wonders why any OPEC or non-OPEC country would want to risk this positive outcome. The next few months will tell the story as to whether 2017 will see a further global recovery in oil or whether oil remains lower for longer. Yesterday, the International Energy Agency (IEA) released its Oil Market Report for December. In the report, the IEA noted that it believes that OPEC produced roughly 34.2 million bbl/d in November, or an additional 500,000 bbl/d from OPEC's recent estimate for the month. These numbers call into question the authenticity of OPEC's reporting and render a 1.2 million bbl/d cut from the cartel significantly less impactful. Undoubtedly, the biggest question mark surrounding OPEC's recent historic production cut is the cartels ability to not cheat on the numbers (which historically has been a problem). If the market senses that OPEC members are not adhering to their newly defined production quotas, prices will turn negative quickly. The next three to six months will provide the market answers as to whether the cartel is strong enough to hold to its newly stated production quotas. The IEA also noted in its December report that it has revised its estimate for Chinese and Russian consumption prompting the agency to raise its forecast for global oil market demand growth this year by 120,000 bbl/d to growth of 1.4 million bbl/d. A strengthening demand picture globally combined with OPEC's recent production cut (should the cartel adhere to the new quotas) will undoubtedly send oil prices significantly higher in the coming months (potentially into the $60-$65 bbl/d range).
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Jason SawatzkyA Canadian Energy expert Archives
October 2020
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