Brent’s rally toward US$60/bbl – a false dawn?
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Oil demand growth may hold the key to market rebalancing
Share price movements can be a good early indicator of changing fortunes. The oil and gas sector had a great month in September, jumping 8% and outperforming the broader global stock market by 6%. It’s more than just rotational buying. The trigger was a sharp rally in the oil price – Brent jumped from sub-US$50/bbl in mid-August and briefly threatened to break through US$60/bbl in a matter of weeks.
So, are there genuine signs that investors should be buying back in? Our view is that the fundamentals are still challenging and OPEC has its work cut out to rebalance the market into 2018.
OPEC, with Russia in tow, has done a good job so far. At the end of last year, chronic oversupply was reflected in record inventory levels. The production cuts implemented at the start of 2017 have taken up to 1.4 million b/d of oil off the market, and we expect Brent to average US$53/bbl this year, up from US$44/bbl in 2016. Without these production cuts, prices would be much lower.
Global supply will grow this year by around 0.8 million b/d.
OPEC countries not bound by the agreement (Libya, Nigeria and Iran), and non-OPEC producers Canada, the US and Brazil, will all produce more. US Lower 48 oil is not a big factor in 2017, with volumes up by just 0.2 million b/d, but that's just timing. More tight oil – much more – is coming down the line in 2018 and beyond.
With demand growth this year of 1.3 million b/d, rebalancing is underway.
Falling crude inventories illustrate that point. But instead of heralding the beginning of the end of the oil market down cycle, we may only be near the end of the beginning – OPEC’s battle to win back a degree of control has some way to run.
OPEC faces a trickier balancing act in the year ahead.
On paper, global supply is set to increase by about 2.3 million b/d in 2018; whereas demand is projected to grow just 1.4 million b/d. OPEC has no choice but to extend the cuts in place to end March through the rest of 2018 if it is to avoid a calamitous repeat of the glutted market conditions that led to sub-$30/bbl a couple of years ago. We have been assuming OPEC would extend the production cut agreement through 2018 since June.
Even net of OPEC cuts we expect volumes to increase by 1.8 million b/d. In the US Lower 48, horizontal rig activity has surged since mid-2016 in response to higher prices, and will deliver 0.85 million b/d of new oil volumes in 2018.
Our latest forecasts have Lower 48 oil production growing at roughly this rate each year till 2023. In 2018 we also expect incremental output from Canadian oil sands, Brazil and Kazakhstan.
Demand could yet be the surprise package that accelerates rebalancing.
Currently, oil demand growth is broadening across the global economy, as commodity-producing economies hit by the downturn rebound. Among oil importers, low prices for three years may be helping stimulate economic growth. China’s economy is buoyant this year, driven by infrastructure build-out which has fuelled diesel consumption. The US, too, is experiencing a bounce in diesel demand. The risks to global demand this year may be on the upside.
Indeed the IEA is far more bullish, expecting 1.6 million b/d of demand growth this year, which would make 2017 the strongest since 2013.
If the IEA proves right, a cumulative extra 0.5 million b/d of demand in 2018 versus our forecast would suggest supply and demand growth are broadly matched.
But it’s a big if, and it would still be an artificial balancing of the market propped up by OPEC cuts. Any sustained rally in price needs a fundamental tightening of supply and demand, and that is unlikely in our view in 2018. And any surge in price could be counter productive in the short-term since it will likely prompt faster investment in short-cycle, price-sensitive tight oil plays and yet more supply to deal with.
You can find our latest oil market views on Wood Mackenzie's Oil Price Outlook.