Thursday, January 18, 2018 /10:19AM / FDC
Factors affecting supply
Rising US crude
The US is the newest swing producer6 on the block. It accounts for 16% of the total global output, but accounts for over 70% of oil production growth. US production increased by 61.6% to 14.48mbpd in September 2017, from 8.96mbpd in the corresponding period in 2011.This boom in production, dubbed the shale revolution, contributed to the global supply glut, and forced down the global price of the commodity.
Developments in technology led to improved cost efficiency in oil drilling and fracking, reducing costs and the price of West Texas Intermediate (WTI).7 On the other hand, Brent Crude continues to strengthen, driven by cut agreements and geopolitical tensions. This has led to a widening of the price spread, making WTI more price competitive. As of January 2nd, Brent traded at $66.96pb and WTI at $60.35pb, compared to their prices of $56.82pb and $52.37pb in the corresponding period in 2017. This represents a 47% increase in the spread.
On the quality side, WTI is lighter and sweeter than Brent Crude and is thus more desirable for end users or refiners. For this reason, in pre-2010, WTI was trading at a premium to Brent. However, the Arab Spring9 introduced supply uncertainties, flipping the premium discount situation. During the period, Brent oil prices gained up to 30%.
The increased competitiveness of US crude has encouraged the shift in demand away from the Organization of the Petroleum Exporting Countries (OPEC) to US crude. This, combined with the falling costs of US production per barrel, provides an incentive for US producers to increase output, and boost market share. This increase in US oil production presents a risk to oil prices.
The Organization of Petroleum Exporting Countries and its allies
The OPEC cartel supplies 40% of the world’s production, and represents 60% of global exports for oil. OPEC is a swing producer in the market, led by de-facto leader- Saudi Arabia. However, with the rise in US output, it appears that OPEC is losing its ability to sway the market. Earlier in the year, in its April report, OPEC urged the US to reduce production levels and to increase market stability. Despite this, US crude production continued to increase. In November 2016, OPEC together with 11 non-OPEC oil producers, such as Russia, committed to make sizeable cuts to their oil production and export levels. The timeline for this was originally June 2017, but was extended to March 2018. At its last meeting for 2017 in November, OPEC and its allies agreed to further extend the deadline to December 2018. Compliance levels have been commendable, with its de facto leader, Saudi Arabia, even cutting more than agreed levels. The market responded to compliance levels within the cartel. The expected reduction in OPEC supply is positive for oil prices.
Unknown events can shake the oil market, but are almost impossible to predict. Unexpected occurrences, such as natural disasters and security problems can lead to a force majeure10, limiting supply and driving up prices. Geopolitical tensions between oil producers or between regions in an oil producing country can create supply concerns. For example, oil prices received a boost in October/November driven by market concerns over US-Iran tensions and the Kurdistan war in the Middle East. An unknown event that affects supply will have an impact on prices. Additionally, market expectations influence the direction of prices. If the market anticipates a reduction in supply in the near term, demand will increase now, leading to higher oil prices.
In 2017, oil prices gained 20.5% year-to-date. While we don’t expect oil prices to record similar gains in 2018, we expect the above factors to introduce a floor to the oil market in the short run, causing oil prices to average higher this year. In 2018, oil prices will be supported by improving economic conditions which boost demand, and OPEC production cuts, which will tighten market supply. Our forecast for the year’s average price stands at $59.5pb, approximately 10.8% higher than 2017’s average. Risks to this projection include US production, geopolitical tensions and slower-than-expected global growth.
Provided domestic production levels remain stable, a higher oil price is positive for Nigeria. Increased oil revenue will support budget plans, reduce the need for borrowing, and boost fiscal spending. An average price of $59pb is 25.5% higher than Nigeria’s 2018 budget benchmark of $47pb. This means more funds can be kept aside as savings. This will also lead to an accretion in the external reserves level and enhance the CBN’s ability to intervene in the exchange rate market.
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