With all the focus on OPEC’s strategy throughout most of this year, other major developments in the oil markets have been overlooked, or at least downplayed, but they will play a large role in keeping the market well oversupplied in 2017, and beyond. Simply put, the oil market will still take longer to rebalance than many analysts had reckoned because of supply-side trends both in OPEC and outside the group.
Next year, a slew of new non-OPEC fields will ramp up to increase the global crude (and condensates) oversupply to a massive 1.8 million barrels per day (mbd) for the first part of 2017, according to a major consultancy.
“Markets are very oversupplied at the moment, and if anything, we expect them to be more heavily oversupplied in the first half of 2017,” Julius Walker, Senior Consultant at JBC Energy, said during an interview at the company’s offices in Vienna.
With all the focus on OPEC’s strategy throughout most of this year, other major developments in the oil markets have been overlooked, or at least downplayed, but they will play a large role in keeping the market well oversupplied in 2017, and beyond.
Projects in Russia, Canada, Brazil, West Africa, Kazakhstan, and the North Sea are poised to come on line and cause balances to balloon once again, and keep a cap on oil prices, said Walker. Moreover, although U.S. shale production has taken a hit amid an extended period of low prices, it appears that production will soon level out and see annual growth again by the end of the next year. Overall, there will be some 1.5 mbd of net supply growth in 2017, and against this backdrop, oil prices ought to remain in the $40-$55 range, JBC estimates.
The expected growth next year will occur on top of a massive 5 mbd of gross new supplies coming on line in 2016. The net addition to the market (+650,000 b/d) is much lower, however, due to sharp fall in U.S. shale, unexpected outages, heavy maintenance, declines in mature fields, and shut-in production.
The bearish outlook is set to persist throughout the rest of the decade, although the surplus will narrow, albeit slowly, until 2021 when supply and demand finally return to balance. The biggest factor in this medium-term assessment is that the $50 level will be high enough for most oil companies. “There still does seem to be a general view that oil supplies will naturally be reduced with these price levels,” said Walker. “But essentially what we’re saying is that’s not the case. Whatever was uneconomic at these price levels has already been turned off, but we’re still seeing supply growth in a number of areas.”
This outlook, of course, could change should OPEC agree on a “significant” cut at its meeting on Wednesday and follow through with actually taking barrels off the market. But even so, the group throttling back on production won’t necessarily bring about a quick rebalance, given how large the oversupply is, how effectively non-OPEC supply can offset output cuts, and how resilient U.S. shale has been. For OPEC to fix market imbalances, it would have to remain committed to an extended cut that would draw down inventories over a period of at least six months. “Even the more ambitious cut scenarios that have been hinted at are probably not enough,” said Walker.
For OPEC to fix market imbalances, it would have to remain committed to an extended cut that would draw down inventories over a period of at least six months.
The non-OPEC projects set to come online next year will do so regardless of price, given that most were sanctioned before the market collapse of 2014. At the same time, prices for U.S. benchmark West Texas Intermediate (WTI) in the $50-$55 range will unleash a large amount of drilling in the shale patch, putting a ceiling on prices and further complicating any decisions OPEC has to make, at the meeting this week or at any in the future.
“The shale sector is ready to go,” Walker said. “There’s been aggressive hedging and companies have trimmed a lot of fat. Any OPEC cut would simply accelerate the recovery of U.S. shale.”
Not only does shale have a large upside; it can also rebound quickly if the prices reach the right level.
“Shale is an entirely different way of looking for and drilling for oil,” said Walker. “You drill more wells more quickly. You can go from making a decision to drilling a new well to producing in just one or two months essentially, if that’s what you want to do. That’s very different from conventional production, where even small projects take at least one to three years to develop. U.S. shale also has extensive infrastructure that is already in place.”
“The shale sector is ready to go. There’s been aggressive hedging and companies have trimmed a lot of fat. Any OPEC cut would simply accelerate the recovery of U.S. shale.”
The price level at which shale drilling will increase varies among companies, but prices in the $50 range, or even lower for some firms, can restore growth, offsetting any cutbacks by OPEC countries. With the amount of non-OPEC supply coming on stream and shale likely to rebound, an OPEC cut would have only a marginal effect.
Demand set for robust growth in 2017
JBC forecasts the large oversupply to occur next year even with demand growth remaining robust. For 2017, JBC sees demand rising by a healthy 1.3 mbd, just slightly above expectations for this year. For the most part, the main factor behind the strength is demand for fuels in Asia, particularly China and India, where consumers will drive most of the growth.
“By and large, with China and India having more or less liberalized their price regimes, it’s been possible to observe a very strong response to lower retail prices,” said Walker.
As a result, Asian demand growth represents half of JBC Energy’s projected increase for 2017, with gasoline consumption increasing by 230,000 b/d, while at the same time gasoil—diesel and heating oil—should see annual growth of around 150,000 b/d, following an unusually weak 2016. In percentage terms, India is growing at a sharper rate than China, in large part because of China’s weaker economic growth, decline in infrastructure spending, and drop in manufacturing. The market should bank on demand in North America growing, too, which will be led by gasoline consumption in the U.S. continuing on its upward trajectory that has come about because of low prices.
OPEC in a bind, prices to settle in $40-$55 range
OPEC is clearly in a bind as it heads into its meeting on Wednesday. Not only does it have to contend with supply growth outside the group, but it has to deal with its own internal struggles. Different members in the group have competing agendas and a number, including Nigeria, Libya, Iran, and Iraq, all have upside potential. Even if a deal is clinched, these producers may up output regardless.
“Oil prices will remain locked in a $40-$55 per barrel window in 2017.”
For a cut to work, JBC argues, the group will need to effectively communicate who will participate in the cut, how the cuts would be shared, and what baseline numbers will be used. In other words, OPEC will have to be transparent in the details it provides to the market.
Despite the oil markets being in uncharted territory with so many moving parts and OPEC policy in flux, prices have remained relatively stable, despite, at moments, periods of volatility. This situation should continue. “Oil prices will remain locked in a $40-$55 per barrel window in 2017, largely irrespective of any actions taken by OPEC Wednesday and beyond,” said JBC in a recent report. “Instead of jumping from one extreme to the other with regard to assessing OPEC’s relevance, market observers may be well advised to pay more attention to the myriad of other factors [such as the underlying fundamentals].”