Thursday, January 14, 2016 8:05 PM / ARM Research
We shift focus to the commodity section of ARM’s core strategy document – the Nigeria Strategy Report. In today’s piece we review developments in the global crude oil market over H2 15 and delineate ARM’s outlook for H1 16.
The glut in the crude oil market persisted into H2 15 as higher OPEC output (+2.1% relative to H1 15) offset declines elsewhere. However buoyed by robust oil demand growth, which hit a near five-year high of 2.2mbpd in Q3 15, the excess narrowed to 1.4mbpd (vs. 2.3 mbpd in H1 15).
Nevertheless, the improvement in oil market fundamentals did little for oil prices which plunged further to an 11-year low ($36.11/bbl) on other concerns. Specifically, the potential opening of spigot in Iran, after signing the historic nuclear deal in July and OPEC’s extant strategy—reiterated at the December 2015 meeting—framed expectation for further expansion in excess oil supply in the coming months. In addition, further strengthening of the US dollar on prospect of tightening US monetary policy exerted additional downward pressure.
Going into 2016, ARM believes these events, as well as increased market share and pricing competition amongst oil producers, after the US joined the league of oil exporters on the lifting of the 40 year old export ban, will shape oil price trajectory. In all, based on the foregoing dynamics and historical price movements, they envisage even more pressure could lead prices to trade within the range of $30.00-$35.00/bbl on average in H1 16.
Latest wave of commodity out spares a few, barely
If the H1 15 performance of commodities was seen as a breather, then the second half of the year brought the next wave of wailing. Especially for oil whose support in the first half (bounce) proved short-lived. Whilst the broader soft commodity basket was similarly depressed, quite a few of our coverage names held onto the signs of recovery that materialized in H1 as demand-supply dynamics became increasingly favourable. Nonetheless, the support for some of these bright lights might prove tenuous due to their weather driven nature but the underlying improvements suggests that the current platform of stability could at least last through H1 16.
OPEC maintains oil production
OPEC supplies rose 2.14% from H1 15 to 38.25mbpd in H2 15. Saudi Arabia continued its production war to retain market share, as they maintained production levels above 10mbpd, as has been the case since March 15. Meanwhile, production in Libya which hit its highest level of 430kb/d since May in October 15 and in Nigeria which increased 40 kb/d M-o-M to 1.9mbpd also in October made up a part of the OPEC nations that boosted production levels despite the low pricing environment. In addition, the outcome of the December 4th meeting resulted in no changes to the corporation’s stance on oil production, as key members such as Saudi Arabia refused to cut production unless other member countries agreed to the same.
Figure 1: Oil Production OPEC (mbpd)
Non-OPEC output slows on capex cuts and pricing wars
In H2 15, total non-OPEC crude oil production increased by 0.60% from H1 15 to 58.50 mbpd, compared with its increase of 1.30 % in H1 15, from H2 142. The higher output from the US, which had been a key contributor to the increase in crude supplies, began to slow, as companies went through more capex cuts and shutdown active rigs to keep their businesses afloat amidst the record levels of crude production from Saudi Arabia. Nonetheless, the decreased pace of production did not ripple into countries outside of North America as Russia, China and Brazil posted healthy increases to production during the period. In Russia, production levels hit a record high in October at 10.78 mbpd, an increase of 135kbpd YoY as domestic producers shifted their focus to developments that could boost output in the short term. On aggregate, global crude oil supply increased by 1.20% from H1 15 to 96.75 mbpd (2.16% YoY).
Global demand picks up, driven by Europe
Global demand increased 1.76% in H2 15 and 1.87% YoY to 95.35mbpd as global oil demand growth hit a four and a half year high of 2.2mbpd YoY in Q3 15. The peak was primarily driven by Europe and the Middle East as both regions added an increase of 2.60% and 3.75% from H1 15 respectively. The economic recovery in Europe was reflected in its industrial production numbers (+1.2% YoY: Oct 15), improved retail sales (+2.4% YoY: Oct 15) and manufacturing PMI indicators (+0.96% MoM: Nov 15). In addition, the positive momentum seen in European car sales continued as data showed an increase for the 26th consecutive month in October 2015 (+3% YoY). Meanwhile in the Middle East, the boost to the demand for crude was driven by Saudi Arabia (+15% YoY)3, driven by the transportation sector, industrial fuels and direct crude burning. The improvements in global demand for crude contributed to the decline in the excess supply glut, which fell 26.32% from H1 15 to 1.4 mbpd.
Figure 2: Excess Supply/Demand (in mbpd)
In spite of the improvements in global demand, the persistence of an excess supply situation (Q2 15: 2.30 mbpd, Q3 15: 1.50 mbpd, Q4 15: 1.40 mbpd) weighed negatively on oil prices, with both Brent and WTI falling below technical support levels of $40.00 (est.). During this period, both Brent and WTI fell to 11 year lows of $36.11/bbl and $34.73/bbl respectively. It appears the renewed strength of the dollar in H2 15 to reach new highs also contributed to the weakness in oil (and other commodities) However, with the decision by the US to lift its 40-year export ban, WTI recovered from its 11-year low to reverse the previous Brent premium with the grades respectively closing 2015 at $37.28/bbl and $37.04/bbl.
Figure 3: Bloomberg Dollar Index and Brent Crude Prices ($/bbl)
Saudi Arabia producing at record levels, as Iran waits on news of sanctions
As the competition for market share continues, we expect Saudi Arabia to continue its production of crude at high levels in H1 16, in spite of the country’s increasing budget deficit ($98 billion in 2015). Partly in consequence of the low oil price environment and its impact on CAPEX cuts, reduced oil hedges and decreased profits, the outlook is for US Shale production to decrease in 2016 as the lagged impact between falling rig counts and crude production begins to materialize. Most recently, US total rig counts fell to a 16-year low of 698 in the week ended December 11th as production hit a year to date low of 9.1mbpd in the week ended September 25th.
Figure 4: US Rig Counts vs. Crude Production
Whilst the falling shale output ostensibly suggests that Saudi’s policy is achieving its goals, a commensurate cutback in Saudi output, whenever the dust settles, may not necessarily imply a rebound for crude prices. One clear factor is the impending impact of Iran’s re-entry into the oil market should sanctions be released in H1 16.
The Middle Eastern nation is expected to contribute 500kbpd to global crude supply following, the removal of the sanctions, which could rise to 1mbpd six months after. In addition to Iran’s potential re-entry into the market, Indonesia’s re-inclusion into OPEC after 7 years may contribute 800kbpd to global crude supply.
Secondly, Russia is expected to continue pumping at record levels in 2016 as it aims to fight off competition for market share in Europe from Saudi Arabia, Iran and Iraq. IEA analysts forecast an increase in Russian crude supply of 120kb/d in 2016 due to the shelter provided for Russian companies through Moscow’s oil tax system. However, the actual rate of increase will be dependent on the impact of international sanctions and the country’s increasing fiscal burden.
Slower economic growth tugs on global demand
We expect the increase in global demand to fall from 1.75mbpd (+1.80%) in 2015 to 1.2mbpd in 20164 as the factors that were associated with the increase in demand begin to fade. In Europe, the recovery from the post-recessionary bounce and potentially warmer winter climate are set to result in a smaller sized increase than the 0.20mbpd increase YoY seen in 2015. In contrast to the slowdown in the aforementioned countries, India will be looking to boost its demand for crude as it has done during the year when demand growth hit a decade high of +15.3% YoY in September 15 stemming from strong economic growth prospects. With a 21% growth in passenger vehicle sales in October 15, Indian demand is expected to increase by 4.56% to 4.2mbpd in 2016.
‘Pricing Wars’ for crude exports could take on new dynamic in H1 16
Current trends reaffirm our expectations, which were set out in our previous report, for price and market share competition amongst the oil players to persist. As Saudi Arabia continues to pump crude at record levels to compete against US producers, who themselves seem to be receiving less boost from the factors that appeared set to help sustain shale production for longer than initially thought, a new front appears to be opening up amongst the conventional crude producers. The battle between Middle Eastern nations such as Saudi, Iraq and potentially Iran, is expected to intensify as the aforementioned nations compete against each other for the energy hungry Asian market made up of India and China. This may result in further discounting of costs associated with crude sales through discounts on actual crude prices or on freight costs. In addition, we reference the decision by the US to raise its export ban which, given its increasing inventory levels, could yet make it a major player in the pricing war as it could export crude at lower freight costs to provide a source of revenue for struggling shale producers. Brent crude prices averaged $48.10/bbl in H2 15, but based on the foregoing dynamics and historical price movements, we envisage even more pressure could lead prices to trade within the range of $30.00-$35.00/bbl on average in H1 16, with a potential recovery towards $40 later in the year