Wednesday, October 11, 2017 02:58 PM / ARM Research
Crude oil market rebalancing in the third quarter of 2017 was ahead of our forecast, as US oil production was partially disrupted by the Hurricane while OPEC stuck to its pact. For context, at the start of the quarter, we had forecasted a slower rebalancing of the crude oil market with excess supply projected to decline to 100kbpd (Q2 17: 400kbpd).
This view was hinged on quick increases in shale production, which we expected to moderate the impact of rising demand and OPEC’s production cut. Irrespective, the impact of hurricane on production made our earlier call look too pessimistic, after having stoked a faster than expected rebalancing. Precisely, crude oil market switched to a deficit in the quarter (- 160kbpd) to drive a bull run in the commodity price.
Further examination of the crude oil market reveals increases in global crude demand over the review period to 98.9mbpd (1.6% QoQ) largely reflecting growth in the OECD region (2.0% QoQ to 47.6mbpd). The growth was driven by rising European demand, a reflection of positive vehicle sales, combined with increases in demand stoked by the re-opening of US refinery.1 Nonetheless, demand was relatively sticky in China and India as economic recovery remained slow.
At the other end, the market witnessed increases in supply (1.0% QoQ to 98.7mbpd), but
the momentum was slower than earlier expected. For us, the mild increase in supply was on the back of further crude production cut by Russia as well as slower than expected rise in US shale activities. Specifically, following Hurricane Harvey which led to a 186kbpd unplanned production outages, US’s supply came in only slightly higher relative to prior quarter (+280kbpd).
This, in addition to the 300kbps cut in Russia’s production, was enough to offset the impact of a rise in OPEC’s supply that was triggered by higher supply from previously battered members: Nigeria (+176kbpd) and Libya (+230kbpd). On balance, a tamer crude supply picture (relative to demand) led to the much-needed rebalancing in the crude oil market in the review period.
Market re-balancing propels best oil price rally since November cut.
After trading below $50/bbl. in July on the back of bearish data from the US, crude oil prices kicked-off a recovery from August. Pertinently, after the re-opening of US refineries2 in the prior quarter, weekly data from the US showed subsisting drawdown in US crude inventories and rig count in the last 8 weeks of the quarter.
The foregoing, combined with knock-on effects of the hurricane contributed to a 20% QoQ increase in the Brent crude price. In terms of sentiment, market switched to a sharp swing in sheer backwardation (longer-dated contracts trading lower than the spot price), indicating a possible decline in crude stocks and positive for prices.
We retain our base case forecast.
In framing our outlook for crude oil prices over the next six-months, we hold our base case assumptions. Firstly, while we think the market has fully rebalance, we expect greater supply from US as the impact of Hurricane subsides to shake the rebalancing. Pertinently, the impact from recent Hurricane has yielded smaller damage compared to past storms with a sizable number of US drillers expected to resume drilling activities in the near term. Also, feelers from the market suggest that higher production from Nigeria and Libya (of 120kbpd and 100kbpd respectively) is moderating the impact of production cut by other OPEC members.
Finally, we think the long-held converse in the US dollar to the Brent posit a likely retraction in crude oil prices. Hence, expectation for further rate hike and unwinding of balance sheet by the US Fed guide to a stronger dollar and consequently lower crude oil prices. Given the above, we think risks are more tilted to the downside and our long-held call of a rebalancing has moved the market’s implied price in line with our call. Based on the foregoing dynamics, we envisage that a rebalancing of the crude markets would leave 2017 prices stable, albeit slightly lower in the last quarter of 2017.
Precisely, we expect the confluence of factors to keep mean crude oil prices at a range of $45 - $50/bbl. with a base case of $50/bbl. The key risk to our forecast will be a slower than expected ramp up in US production as well as higher compliance by OPEC and non-OPEC.
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