Wednesday, July 19, 2017 12.39PM / ARM Research
In this cut-out of “The Nigeria Strategy Report”, we shift focus to the commodities market with our review of crude oil markets featuring in today’s excerpt. Having done an extensive review of the market over H1 17, we then delineate our outlook on same going forward with keen attention paid to related developments within major demand and supply-moving countries.
On the heels of a bull run in December 2016 (+12.6% MoM) which was driven by production cut announcement by OPEC and non-OPEC members, crude oil prices failed to sustain the rising trajectory due to concerns about compliance to the production agreement and rising US shale activities in the review period. However, though crude oil price declined by 16.8% in H1 17, mean prices at $53.25/bbl. are 9% and 18% higher relative to H2 16 and 2016 respectively.
Global oil supply declined 1.7% QoQ in Q1 17 to 97.7mbpd. This decline in production was triggered by lower productions from OPEC (-3.7% QoQ to 31.6mbpd) and non-OPEC countries (-0.3% QoQ to 57.8mbpd) with impact of non-OECD region particularly notable. Declines in non-OPEC supply was buoyed by stepped-up compliance from producer’s subject to the production cut agreement with output in FSU region lower in the period. On the demand side, global crude oil consumption dipped in Q1 17 to 96.7mbpd (-1.0% QoQ) driven by declines in OECD (-1.3% QoQ) and non-OECD (-0.8% QoQ) countries.
Overall, coalescing the demand and supply picture guides to a steady rebalancing in the oil market over 2017 with an equilibrium expected in 2018, which aligns with the IEA and OPEC outlook. That said, the risk to the supply picture remains higher than expected increase in US production as oil prices edge northwards.
For us, oil market recovery remains on track but brittle and bearish sentiment is likely to weigh on prices until our more bullish fundamental outlook is confirmed by US inventory over the coming months. Based on the foregoing dynamics, we envisage that a slower rebalancing of the crude markets would leave 2017 prices stable, albeit slightly lower in H2 17. Precisely, Brent crude prices averaged $53.25/bbl. in H1 17 and we expect the slower rebalancing process to keep it at a range of $45 - $50/bbl. in H2 17.
Shale deluge smothers crude market bang to a whimper
On the heels of a bull run in December 2016 (+12.6% MoM) which was driven by production cut announcement by OPEC and non-OPEC members, crude oil prices failed to sustain the rising trajectory due to concerns about compliance to the production agreement and rising US shale activities in the review period.
Precisely, we pin the 2% slide in Brent crude price to $55.7/bbl. in January to the faster than expected increases in crude oil inventories and production in the US. In the subsequent month though, shale had a less telling impact on proceedings with lower crude oil production from OPEC countries (-900kbpd QoQ) and Russia (-100kbpd QoQ) moderated pass-through from activities of the US producers to leave prices marginally lower in February (-0.2% to $55.59/bbl.).
That said, a recovery in US crude stocks compounded re-invigorated downward pressures on crude prices in March (-5% MoM to $52.83/bbl.). While news of OPEC-cut extension provided support for crude in the start of April, the commodity faced a free fall in the latter weeks of April (-2.1% MoM) and May (-2.7% MoM) and broke the critical support level of $50/bbl. to touch $48.48/bbl. by the first week of May. The declines followed feelers from the market which suggested that OPEC would not deepen its production cut.
Irrespective, positive hints from OPEC ministers, which suggested that the institution will embark on more aggressive cuts farther out, began to nudge oil prices higher closer to the May 25th OPEC meeting. Surprisingly, although OPEC eventually agreed to extend production cut at the meeting, its decision to leave the level of cut unchanged left the market disappointed. Consequently, crude oil prices declined steeply (-5%) in the subsequent two trading sessions. The foregoing, combined with news of US’ imminent withdrawal from the Paris climate deal which should prompt higher drilling in the country, kept prices lower for the month of June (-6% MoM to $47.27/bbl.) Overall, though crude oil price declined by 16.8% in H1 17, mean prices at $53.25/bbl. are 9% and 18% higher relative to H2 16 and 2016 respectively.
Figure 1: Brent and WTI price trend ($/bbl.)
Production cut moderates global oil supply…
Global oil supply declined 1.7% QoQ in Q1 17 to 97.7mbpd. This decline in production was triggered by lower productions from OPEC (-3.7% QoQ to 31.6mbpd) and non-OPEC countries (-0.3% QoQ to 57.8mbpd) with impact of non-OECD region particularly notable. Declines in non-OPEC supply was buoyed by stepped-up compliance from producer’s subject to the production cut agreement with output in FSU region1 lower in the period. Furthermore, output in Libya and Iran—which are spared from the cuts—contracted by a combined 100kbpd as the El Sharara oil field was shut-down due to a blocked pipeline. Notwithstanding the decline in global supply, America production expanded 1.0% QoQ to 19.8mbpd largely on the back of higher output in US (+190kbpd) at 9.1mbpd as crude oil prices crossed $50/bbl. Technological improvements such as horizontal drilling and fracking have given US producers the ability to turn production on and off quickly to respond to price changes in the market. Overall, higher compliance by OPEC members largely drove the supply contraction. To underscore the level of compliance by OPEC, the average YTD compliance rate (104%) has modestly surpassed the expected cut—as opposed to outcomes of prior cut agreements.
Figure 2: Trend in US, Saudi Arabia, and Russia Supply (mbpd)
Figure 3: OPEC and non-OPEC production compliance
Slowdown in hitherto unfaltering growth regions pulls back global demand
On the demand side, global crude oil consumption dipped in Q1 17 to 96.7mbpd (-1.0% QoQ) driven by declines in OECD (-1.3% QoQ) and non-OECD (-0.8% QoQ) countries. The decline in the OECD region was primarily due to lower demand in the US (-495kbpd), Germany (-100kbpd) and Japan (-100kbpd). Precisely, higher demand in the US (21% of global demand) reflected declines in gasoline, LPG and ‘other products’ consumption—an echo of stuttering industrial activities as well as other factors related to transportation sector such as the drop in vehicle sales and higher retail fuel prices that led to a decline in miles driven. On the other hand, slower than expected industrial activity in Germany, UK2, and Turkey supported decline in OECD’s.
Similar to the OECD, non-OECD demand pulled back by 0.8% QoQ to 50mbpd largely driven by decline in India’s demand (-0.7% QoQ), despite demand growth in China3 (+1.7% QoQ). India’s demonetization policy which clawed back previously resilient demand growth to reverse in Q1 17, more than offset recoveries seen in other non-OECD countries. Overall, while supply glut persisted over the period at 400kbpd, the glut moderated pointedly from 1.13mbpd in 2016, though at a slower than expected pace.
Figure 4: Crude oil Supply/Demand vs. Balance (in mbpd)
OPEC takes safe play nine-month extension
At the end of its May 25 meeting, OPEC and eleven non-OPEC producers (including Russia) agreed to maintain the supply cuts to 1.8mbpd level for an additional nine months ending March 2018, with a target of returning global inventory levels towards its 5-year average, thus rebalancing the market. In terms of monitoring compliance level and the impact, a meeting with OPEC and non-OPEC members is slated for November 30 in Vienna. Overall, we are of the view that the nine-month extension to agreed cut will keep a slight degree of control of the market, despite supply pressure from shale producers.
Table 1: Production cut for individual OPEC members
Although global crude oil inventory—a gauge for the rebalancing by the cartel—continues to remain sticky, a deeper cut expected by the market which would have supported a faster inventory depletion, would send oil prices higher in the short term and bolster a faster increase in production by shale producers.
Thus, we think OPEC’s position to maintain current quota hinges on a plan to put a floor on oil price at $45-50/bbl. and wait for the impacts of production cut to balance the market and drain inventories, thus providing slower, albeit sustainable support to prices4.
Based on our analysis, we forecast a 5% drawdown in global inventory for the rest of the year, and a 10% YoY from 2018-2010—bringing it closer to its 5-year average of 300million barrels.
Figure 5: Global commercial inventory (million barrel)
Rebalancing on the way, though tempered by higher US output
Supported by extension in production cut, we project a drawdown in the supply glut to 100kbpd in 2017, while we forecast a rebalanced market in 2018, largely hinged on rising demand which is expected to slightly outpace supply. On the demand side, the IEA estimates that crude oil demand should rise by 1.3mbpd in 2017 a view shared by OPEC whose analysis projects a YoY growth of 1.27mbpd in 2017. The demand is expected to be buoyed by China’s resilient demand and pick-up in India’s demand as the country regains momentum after being dragged by the demonetization policy even as prospects brighten in both Brazil and Russia, along with their close trading partners. For China, its teapot refineries are expected to add around 200kbpd – 400kbpd to China's overall crude oil import growth over 2017. The foregoing combined with lower retail pump prices, rising vehicle sales and ongoing efforts to raise strategic and commercial crude oil stocks is expected to support Chinese demand.
On the supply side, given full compliance by OPEC as well as expected increase in compliance level by non-OPEC, our forecast for higher US production should take about 60% of agreed cut. Supporting our view of increase in compliance by non-OPEC, particularly Russia, the upcoming election and expectation of higher fiscal spending in the country will drive Russia’s willingness to support the floor in crude oil prices. Overall, coalescing the demand and supply picture guides to a steady rebalancing in the oil market over 2017 with an equilibrium expected in 2018, which aligns with the IEA and OPEC outlook.
That said, the risk to the supply picture remains higher than expected increase in US production as oil prices edge northwards. Oil production in the US continues to trend upwards at c. 9.2mbpd – an increase of 400kbpd since the start of the year. US producers, particularly the Permian region have continued to improve production cycles, reduce extraction cost with break-even prices plunging 60% to circa $38/bbl. The combination to greater efficiency, relaxed regulation and increased investment supports this downside risk.
Consequently, the EIA forecast a YoY growth of 1mbpd for US crude production in 2017 which recent drop in oil prices is unlikely to stall the rise as producers have hedged most of their production when prices hovered around $50-$55/bbl.
Table 2: Crude Oil Market (Historical & Forecast)
The frequently referenced indicator by OPEC, which is the level of OECD commercial inventories relative to their five-year average, supports our view. Though reaching the 5-year average target is unlikely—given rising US supply and limited upside to global demand—we think the spread between the current level and the target will contract further, supporting our view of a rebalancing in H2 17. Therefore, assuming strict compliance with production cut and a further contraction in OECD commercial inventories, supported by a pick-up in global demand buoyed by China,
India as well uptick in US demand, we are of the view that the market is headed for an equilibrium in 2018. Notwithstanding higher production for US, we see a cap at the 1mbpd growth as the future’s curve term structure offers less attractive conditions for further hedging. In the long term though, the resilience in production from US and the risk to global demand growth stemming from the increase in alternative energy remain downside risk to the rebalancing process.
Thus, the oil market recovery remains on track but brittle, and bearish sentiment is likely to weigh on prices until our more bullish fundamental outlook is confirmed by US inventory over the coming months. Based on the foregoing dynamics, we envisage that a slower rebalancing of the crude markets would leave 2017 prices stable, albeit slightly lower in H2 17.
Precisely, Brent crude prices averaged $53.25/bbl. in H1 17 and we expect the slower rebalancing process to keep crude oil prices at a range of $45 - $50/bbl. in H2 17.
From ARM’s H2 2017 Nigeria Strategy Report
1. After Bullish Run, Portfolio Flows to EM Look Set To Moderate - Nigeria Strategy Report H2 2017
1. Increasing Oil Output in Angola to Drive Modest Recovery
2. Nigeria: Is The Recovery For Real? - LBS EBS – July 2017
3. Project Changes in Mozambique Prompt Construction Forecast Revision
4. Tentative Recovery in Zimbabwe Will Face Destabilizing Headwinds
5. Slow Growth in Egypt Until Structural Adjustment Bears Fruit
6. Nigeria’s Borrowing Spree…Any Cause for Worry?
7. Economic Associates States Report - July 2017 Edition
8. Medium Term Growth Potential Still Below 2% in Advanced Economies
9. Sub Saharan Africa Economic Outlook Ahead of Upcoming Elections
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