Reviews & Outlooks | |
Reviews & Outlooks | |
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Wednesday, July 24, 2019
05:07PM / ARM Research / Header Image Credit: Yahoo Finance
At the start of the year, we had projected that growth in crude oil supply from US and other nonOPEC producers, as well as weaker pace of growth in demand will result in an extension of the net surplus position in the oil market. Accordingly, based on our interpolation between changes in net supply and Brent crude, we forecast crude oil price of $50/bbl.-$60 bbl (base case of $55.95), with upside risk to our forecast stemming from full compliance with the OPEC and allies output cut, and worsened geopolitical tensions in Venezuela and Libya which could settle oil prices at $60-$70/bbl. range. Largely in line with our bull estimate, crude oil prices tip-toed to close H1 19 at $66.6/bbl. (24% higher than FY 18 close) stemming from overcompliance by OPEC (especially Saudi Arabia) as well as unprecedented involuntary cuts by Iran and Venezuela, all of which more than outweighed shortfall in demand to moderate the market surplus to 190kbpd. compared to H2 18 average of 1.3mbpd.
Over the rest of the year, we expect increased net
surplus of 630kbpd, underlined by our projection of supply growth over H2 19 by
1.14mbpd largely reflecting increased outflows from US and Canadian producers
which will offset expected declines OPEC producers. On the other hand, we envisage
increased demand going into the second half by 690kbpd, anchored on expectation
of increased crude consumption by China teapots as well as in the US and India.
Thus, based on the interpolation of the foregoing, we increase our H2 19
estimate for average oil price to $58/bbl. from $52/bbl, which brings the 2019
full year average price forecast to $62.3/bbl.
Oil prices trended in line with our
Bull case thesis
At the start of the year, we had projected that
growth in crude oil supply from US and other nonOPEC producers, as well as
weaker pace of growth in demand will result in an extension of the net surplus
position in the oil market. Accordingly, based on our interpolation between
changes in net supply and Brent crude, we forecast crude oil price of $50/bbl.-$60
bbl (with a base case of $55.95), with upside risk to our forecast stemming
from full compliance with the OPEC and allies output cut, and worsened
geopolitical tensions in Venezuela and Libya which could settle oil prices at
$60$70/bbl. range. Largely in line with our bull estimate, crude oil prices
tip-toed to close H1 19 at $66.6/bbl. (24% higher than FY 18 close) stemming
from overcompliance by OPEC (especially Saudi Arabia) as well as unprecedented
involuntary cuts by Iran and Venezuela, which more than outweighed shortfall in
demand to moderate the market surplus to 190kbpd. compared to H2 18 average of
1.3mbpd. On a quarterly basis, average Brent crude oil prices printed at
$63.83/bbl. over Q1 19 (7.2% lower QoQ) and $68.47/bbl. over Q2 19 (+7.3% QoQ).
Geo-politics changed the narrative
Geopolitical tensions had more impact in dictating
the direction of oil prices over most of the first half of the year. In fact,
this put fundamentals on the back seat and paved the path for a new narrative.
Heated tensions in Iran increased risks to smooth oil supply, after the initial
waiver granted to eight countries (including India, China, Japan etc.) – who
accounted for 70% of Iran’s oil exports – by the Trump-administration ended on
May 1st. This led to drop in Iran oil production from 2018 high of 3.84mbpd to
the record low of 2.1mbpd in June. Series of events, including attack on two
Saudi Arabian tankers, seizure of Iran tankers by British Government and an
attempted retaliation, shooting down of a US jet, and the breach of the nuclear
agreement by increasing Uranium enrichment worsened the outlook for a peaceful
resolution in the interim. Further espousing the impact of the geo-political
tension were lingering tensions in Libya and Venezuela. While outputs in Libya
have surprisingly improved compared to start of the year (June: 1.13mbpd vs.
830kbpd), despite increased attacks in Tripoli, threats to production linger.
On the other hand, Venezuela’s production has consistently gone south from
1.36mbpd average in 2018 to 700kbpd in June. For Venezuela, it appears
sanctions will intensify as the Trump administration continues to increase
pressure for an end to the Maduro’s government.
OPEC+ leads in Global oil supply
cuts
A conglomerate of the voluntary and involuntary
cuts from OPEC producers triggered decline in global oil supply by 1.59mbpd to
100.20mbpd in H1 19 relative to 101.79mbpd in H2 18. Notably, while shale
production over the period grew 470kbpd, reaching a record high of 12.2mbpd for
the first time in May, the stronger cut by OPEC+ (of 1.71mbpd) drove market
supply lower in H1 19. Among the Cartel, Saudi Arabia spearheaded the cuts, as
the de-facto leader took on cuts of 618kbpd over H1 19, which offset increases
from noncomplying members.
Meanwhile, for Russia (the key OPEC+ ally),
compliance with the revised quotas, which kicked off in January 2019 was quite
debatable. The cuts required Russia additional cuts of 230kbpd to 11.2 mbpd.
However, Russia was not as bullish for higher oil prices as its ally but was
comfortable with prices hovering around $60/bbl, according to statements made
by the energy minister Alexander Novak. However, the Ural taps were forced shut
after reports of contamination of oil that flowed through the Druzhba pipeline
to Europe in late April. This resulted in the 700kbpd capacity pipeline halting
production for a few weeks. Transneft (operator of the Druzhba pipeline)
estimates that 22million bbls of contaminated oil were exported across
countries. Thus, average daily production dropped 180kbpd over April to May to
11.3mbpd.
Meanwhile, the other involuntary supply cuts
stemmed from shortfalls in outflows from Iran and Venezuela, with average daily
production over H1 19 down 730kbpd and 290kbpd to 2.54mbpd and 0.94mbpd,
respectively, compared to H2 19. Ironically, Trump’s propagated sanctions lent
a helping hand in driving the bullish factors. Venezuela’s sanctions on January
28th also took the market by surprise and drove brent prices higher. Meanwhile,
skepticism regarding extension of the Iran sanction waivers (which were
enforced in November 2018) were cleared after Trump announced withdrawing the
waivers in April to take effect in May.
Weak global economic growth takes a
toll on Demand
Global oil demand declined 450kbpd over H1 19 to
100.01mbpd, reflecting decline in consumption among OECD countries (-900kbpd)
which offset increase in non-OECD countries (+450kbpd). Demand was weaker in
the first quarter (99.7mbpd) but showed improvement in the second quarter (100.3mbpd),
following pickup in consumption among the non-OECD countries. Faltering demand
in the US, Canada and Europe, were major drivers of the weak OECD demand
recorded so far this year, while demand in China supported demand growth among
the non-OECDs.
Over in Europe, demand dropped by 370kbpd to
14.04mbpd. The erosion in refinery margins, which dropped from a high of
$11.53/barrel in November 2018 to as low as $1.81/bbl in June depicted the
extent of weakness in demand witnessed over the period. Specifically, slow
growth in Germany following declines in industrial production (1.74% YoY) and
units of car production over the first five months of 2019 have constituted to
the drag in growth across the Euro Zone.
For the non-OECDs, oil consumption remained solid
in China despite lingering trade tensions with the US. China’s daily average
consumption increased 310kbpd reflecting resilient growth over the first half
of the year (6.4% YoY in Q1 19 and 6.2% YoY in Q2 19). That said, the
increasing demand for crude stemmed from new large-scale private refineries
(also known as the teapots) which commenced operation in the first half of the
year. The onboarding of the new 400kbpd capacity refinery by Hengli
Petrochemical Co. as well as new refinery by Zhejiang Petrochemical with same
capacity propelled the increased demand. Data by the Chinese General
Administration of Customs showed crude oil imports over the first half of the
year averaged ~9.87mbpd which is 8.8% higher YoY.
Permian Gulf Spurs Shale Torrent
As mentioned above, for the first time on record,
US daily production crossed 12mbpd in April and hovered above it to touch
12.2mbpd in June. Most of the increase stemmed from the Permian basin (~64% of
the DPR regions), wherein average daily production YtD increased by 867,825
bbls YoY to 4.04mbpd. In addition, the Bakken, Eagle Ford and Niobrara regions
also recorded increases in average daily production by 194,283bbls, 108,777bbls
and 108,667bbls YoY respectively. The increases reflect payoff from the
additional 43 rigs added over the year – and improvement in production per rig
by 3% YoY across regions – which pushed total rigs count to 672 at the end of
H1.
Rising US oil production efficiencies stemming
from more improved fracking of shale rocks have boost the outlook for a
potential US oil surge in the near term. However, the outflows, although
touching new record-highs, have been held back by constraints on pipeline
capacities. Going by available oil programs by the top upstream players, ~2mbpd
production capacities are estimated to be added over the second half of 2019.
With the new capacities coming on board, we see scope for further increases
over H2 19 to average 12.74mbpd compared to 12.0bpd average daily production in
H1 19
Geo-political tensions, not
voluntary cuts, to keep OPEC at bay
On OPEC, going further into the year, while the cartel members voted to extend the oil cuts agreement going into March 2020, we still expect non-compliance, or at best, less extent of compliance in the second half of the year. To buttress the foregoing, latest data by OPEC shows Saudi Arabia, for the first time this year, recorded an upturn in production by 126kbpd to 9.8 mbpd in June. However, this remains well below the stipulated 10.31mbpd quota. The Saudi government also affixed a time frame to keep production below 10mbpd through August. While Saudi is well able to keep production within its boundaries, we see room for increase over H2 19 compared to the record lows in H1 19. Further compounding concerns of non-compliance by member countries is the extent of increase which emanated from Nigeria (+129kbpd MoM to 1.86 mbpd in June), months after launching the 200kbpd capacity Egina field. For the OPEC+ key player, Russia, we project a recovery from the oil contamination which occurred in Q2 19, and factor in non-compliance to the cuts, albeit by slight margins.
That said, we think rising tensions in Iran, Libya
and Venezuela are likely to keep the expected increases in check. Iran touched
record low levels of production and does not appear to be reverting anytime
soon, while crises in Libya and Venezuela do not appear to be losing steam. We
project further cut-backs in Iran and Venezuela production by 467kbpd and
220kbpd which will offset increases from Saudi Arabia and Nigeria by 280kbpd
and 120kbpd, respectively. For Russia, we estimate average daily production of
11.58bbls which is 90,000bbls more than H1 19. Overall, we forecast decline in
OPEC production over the second half by 305kbpd to 29.9mbpd, compared to H1.
Closed WTI-WCS spreads to ease
Canadian crude cuts
Over in Canada, earlier in January curtailments
were placed which required oil cuts by 236kbpd by oil majors in a bid to clear
inventory build-up and close the spreads between Canadian’s Western select
prices and the WTI. Successfully, the WTI-WCS spread narrowed from $29/bbl in
November 2018 to $13.74/bbl at the close of H1. As a result, the Alberta
government began to ease the curbs on oil sands outputs. From the initial
stipulated cut of 325kbpd in January, this is scheduled to reduce to 95kbpd by
August. The Alberta reduction are well-spaced, with 25kbpd increases allowed in
July and August apiece. Considering the successful neutering of the gaps, we
think the Alberta government will continue to manage the production outputs
going into the rest of the year. To mention, oil producers have placed demand
on government to ensure railway infrastructures are in place in exchange of
ensuring compliance with the stipulated cuts. In addition, the approval for
expansion of the highly controversial Trans Mountain pipeline in June from the
Alberta to British Columbia will increase outflow by 3 times to 890kbpd and
points to increased crude from the region. That said, going into the rest of
2019, we increase our forecast output growth to 160kbpd from 120kbpd earlier in
the year.
Weak global growth continues to
strangle demand
On the demand side, we remain pessimistic with our
projections going into the second half of the year due to concerns of global
economic growth. However, our expectations for demand in China have been tuned
up a notch on the positive, underlined by the new refiners which came on board
in H1 19. While refinery margins (Singapore-Dubai Hydrocracking refinery
margin: from $5.5 in H2 18 to $3.3/bl in H1 19) have thinned out due to the
supply glut, we think the increased export quotas by the Chinese government
would help improve flows. Thus, we increase our demand forecast for China over
H2 to 14.57mbpd (previously 14.26mbpd). Overall, we expect stronger demand in
H2 18 compared to the H1, upheld by the summer driving season in Q3 as well as
winter season in Q4. Overall, we project global demand of 100.71mbpd over the
second half of the year.
Oil prices revised higher
Overall, we expect market balance to remain in a
net surplus, with average of 630kbpd over the second half of the year. This is
underlined by our projection of a supply growth in H2 of 1.14mbpd (previous
estimate of 1.7mbpd) reflecting reduced expectation of non-compliance by the
OPEC+ producers and disruptions from the Middle East producers. On the flip
side, US production is expected to be higher, following ease in pipeline
capacities. On the other hand, we are more optimistic on demand growth going
into the second half, with demand growth expectation of 690kbpd (previous
estimate of 300kbpd), largely due to increased consumption by Chinese teapots.
Thus, based on the interpolation of the foregoing,
we increase our H2 19 estimate for average oil price to $58/bbl. from $52/bbl,
which brings the 2019 full year average price forecast to $62.3/bbl. That said,
we believe on slower increase in supply by 450kbpd owing to unimproved ease in
US pipeline constraints, hits from natural disasters as we approach hurricane
season and better than expected compliance to stipulated cuts by OPEC+
producers (especially Saudi Arabia and Russia) could send oil prices to $76 -
$80/bbl. over H2 19 (FY 19: 71.06/bbl). On the flip side, downsides to our
projections could stem from a much worse impact of the lagging growth across
global economies which could pressure demand growth, as well as possible glut
from US ramp up in supply and loosed compliance from OPEC+ producers. This, we
estimate could push oil prices to as low as $56/bbl. over H2 19 (FY 19: $61.1).
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Research 234 (1) 2701653 research@armsecurities.com.ng
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