After hitting a cyclical high in October 2018, oil prices fell back in the ensuing weeks. The price plunge continued in December even after OPEC+ announced production cuts of 1.2 million barrels per day (mb/d), evidence that the market was skeptical of the group’s ability to balance the market in the face of relentless supply growth from U.S. shale and weakening global demand.
Despite a range of uncertainties looming over the oil market this year, there is a growing sense that OPEC+ might be able to succeed in balancing the market after all.
Since late December, however, oil prices have begun to creep back up, rebounding by about 20 percent as of mid-January. Despite a range of uncertainties looming over the oil market this year, there is a growing sense that OPEC+ might be able to succeed in balancing the market after all.
OPEC+ cuts drain the surplus
OPEC production fell by 630,000 barrels per day (b/d) in December compared to a month earlier, a sharp reduction that preceded the implementation of the OPEC+ agreement. Saudi Arabia accounted for about 400,000 b/d of that decline. The Saudi government has signaled that it would cut production by another 400,000 b/d this month, which would take output back down to 10.2 mb/d.
While Saudi Arabia is doing its part, production cuts from other members are more unclear. Russia has shown signs of slow-walking its output reductions, indicating that it would lower output by 50,000 to 60,000 b/d in January. Saudi oil minister Khalid al-Falih told CNBC on January 13 that the cuts from Russia are phasing in “slower than I’d like, but they’ve started.” Meanwhile, production from Iraq edged up in December while the UAE and Nigeria held output above agreed upon levels in December just before the start of the deal. Member countries vowed to cut beginning in January, but the market has been skeptical.
Nevertheless, al-Falih struck a tone of optimism at a public forum in Abu Dhabi in recent days. “We’ve done enough and been decisive in our action, not only the kingdom but other countries,” he said. Al-Falih added that if more needs to be done to balance the market, “we will do it.” Several OPEC officials have repeatedly suggested over the past month that the group would be willing to extend the cuts through the end of the year. “If we look beyond the noise of weekly data and vibration in the market, I remain convinced we are on the right track,” al-Falih said in Abu Dhabi.
Indeed, a growing number of analysts see the supply surplus that hit the market in the fourth quarter of 2018 as temporary. “Gloom and doom hang over the oil market as fears about global economic growth and booming US shale oil production have led to a synchronised selloff in both oil and equities,” Bjarne Schieldrop of SEB said in a new report. But “[p]roduction cuts by OPEC+ together with lower prices will in our view be enough to balance the market, avoiding a strong rise in inventories.”
To be sure, there isn’t exactly a consensus. For instance, the EIA still sees relentless U.S. production growth leading to a supply surplus that could persist over the course of this year. The agency says the global oil market could see inventories rise by an average of 0.2 mb/d in 2019. Ongoing production gains from U.S. shale will complicate the calculus for OPEC+, leaving them with little choice but to keep the supply curbs in place. “Given that U.S. oil production remains in full swing, OPEC will hardly have any other option” but to extend the cuts through the end of 2019, Commerzbank wrote in a note.
However, on the more bullish side are those like Bank of America Merrill Lynch, which predicts a supply deficit in the near future. “On the supply side, we estimate volumes from the OPEC+ group will drop by 2.6mn b/d sequentially from 4Q18 to 4Q19 and on average by 1.6mn b/d from 2018 to 2019,” analysts from Bank of America Merrill Lynch wrote in a January 10 note. “On a net basis, we see aggregate YoY global oil supply growth of just 400 thousand b/d in 2019 and a deficit building into the summer months.” The investment bank argues that the OPEC+ cuts and the impending losses from Iran as sanctions waivers expire could push the oil futures curve back into a state of backwardation – a situation in which near-term oil prices trade at a premium to longer-dated futures. Backwardation is both a symptom and a driver of a tightening oil market.
The production cuts, plus the stated desire between OPEC and the non-OPEC coalition to continue to manage the market on an indefinite basis, may also reduce volatility. “We think a pattern of high compliance with the deal, and the development of a longer-term accord between OPEC and its OPEC+ partners should help reassure the market that the supply side of fundamental balances will be managed more stringently than in 2018,” Standard Chartered wrote in a note.
Every market forecast has certain assumptions built in, and analysts lay out caveats and degrees of uncertainty. But a long line of market watchers generally think that the OPEC+ cuts will push the market closer to some measure of “balance,” even if they disagree over the precise numbers.
However, there are a few overarching uncertainties that could leave forecasters wide of the mark. First, the fate of global economy and the possibility of an economic recession could severely impact demand. Second, the expiration of Iran sanctions and the degree to which Iranian supply is knocked offline will have an outsized impact on the oil market this year. Finally, the pace of U.S. shale growth will be under the microscope. Most analysts believe that the shale industry won’t be able to match the explosive growth of 2018, but a deeper slowdown could go a long way to tightening up the market.
In the meantime, the OPEC+ coalition plans to meet and review the status of the production cuts in March, followed by a minister’s meeting in April where they could decide to extend the cuts through the end of the year. As of now, the supply curbs are scheduled to expire at the end of June.