Analysis: OPEC's success may be its own undoing, as oil market may overtighten

326  Views   |   Tuesday, February 6, 2018

S&P Global Platts Analytics estimates that excess stocks of oil in storage have largely already drained and that the rebalancing is more or less complete, taking into account the growth in demand over the last three years and line-fill volumes required for new infrastructure builds.

Analysis: OPEC's success may be its own undoing, as oil market may overtighten

London (Platts)--2 Feb, OPEC oil ministers have taken pains to head off any rumors that they will abandon their production cuts prematurely, saying that despite higher oil prices in recent weeks, global inventory levels were still much too bloated -- by some 100 million barrels -- to even consider the idea.

But do the ministers protest too much? Some analysts say they believe stocks are far less than OPEC has declared.

S&P Global Platts Analytics estimates that excess stocks of oil in storage have largely already drained and that the rebalancing is more or less complete, taking into account the growth in demand over the last three years and line-fill volumes required for new infrastructure builds.

The danger is that OPEC overshoots on tightening the market, which could exacerbate the backwardation in prices, prolong the rally in near-term prices, and ultimately erode demand.

That is what happened in 2014 after years of stable, high oil prices at or above id="mce_marker"00/b, which helped prompt the boom in US shale growth and trigger a severe market slump that persisted until the current OPEC/non-OPEC output agreement was reached and the cuts started to bite, head of S&P Global Platts Analytics Chris Midgley said.

Midgley added that he was "less concerned this time about shale production growth," saying that these barrels will be needed to meet strong demand growth this year, and that producers are showing far greater fiscal discipline and focusing primarily on cash flow over output.

A price surge may not happen until the second half of the year, given seasonal demand patterns, but it's a situation that "we need to watch carefully," Midgley said.

Goldman Sachs drew an even more bullish conclusion, saying in a note to clients Thursday that "the rebalancing of the oil market has likely been achieved, six months sooner than we expected."

The investment bank revised up its forecast for demand growth in 2018 and forecast that oil prices could rise to $82.50/b by mid-year. ICE Brent futures were trading at $69.48/b at 1130 GMT Friday.

Even the US Energy Information Administration's report Wednesday that US crude production reached 10.04 million b/d in November, the highest in 47 years, could be masking tightness in some parts of the market, independent analyst Anas al-Hajji said.

Much of US production from shale formation has been in light or ultralight sweet crudes, while the vast majority of OPEC's production cuts have come from heavier, sourer grades.

Though he said he believes that the market remains oversupplied, he added that ultralight crudes "have a different market from crude below 40 degree API."

Refineries in the US Gulf Coast, the world's largest refining region, are largely optimized to process heavier crudes, and Saudi Arabia, OPEC's largest producer, has deliberately targeted the US with export cuts to encourage the drawdown of stocks there.

"There is a case to be made that the market is even tighter than [supposed] if the portion of inventories with API above 40 degrees has increased in recent years and months," Hajji said.

 

TWO-MONTH LAG ON STOCKS DATA

Many forecasts, including the International Energy Agency's, still see elevated inventories that will remain surfeit in 2018.

In its most recent monthly oil market report in January, the IEA said recent price gains would lead to "explosive" growth in US shale production this year and warned that demand growth could underwhelm because of the same price gains.

The agency, whose next forecast is scheduled for release February 13, estimated that oil stocks held by OECD nations as of November were about 90 million barrels above the five-year average that OPEC has said it is targeting with its cuts.

OPEC has pegged OECD oil inventories at 133 million barrels above the five-year average as of November.

Investment bank UBS forecasts that supply growth will outpace demand growth in 2018, adding that "current prices, if sustained, could prompt a renewed inventory build-up."

Inventories are reported with a two-month lag, so by the time they have reached the five-year average, OPEC may be late to react.

Saudi energy minister Khalid al-Falih, who chairs a six-country monitoring committee overseeing the OPEC/non-OPEC production cut agreement, suggested at a January 21 meeting in Oman that the coalition may need to be more nimble with its inventories target and tweak it to take into account crude grades and regional inventories.

The comments signaled that ministers are conscious that the cuts may be causing imbalances or unfavorable economics for their crude in their competition with US producers, even as they insist that the global market is still glutted. They are also perhaps an indication that the coalition may be willing to adjust its cuts to respond to tightness in some markets.

"We need to dig a little deeper, whether it's inventory level by region or by type of crude and make sure that [we] do not supply the market with the wrong type of crude prematurely," Falih told reporters.

That the outlook for 2018 has yet to come into focus a mere five weeks into the year is what is prompting OPEC and its partners in the output agreement to declare for now that they intend to maintain the cuts as scheduled through the end of the year.

The deal calls on OPEC and 10 non-OPEC countries led by Russia to cut some 1.8 million b/d in supply. OPEC has a production ceiling of about 33.7 million b/d under the agreement, when the 14 members' quotas are added up, including for formerly exempt Libya and Nigeria, who were given a combined 2.8 million b/d cap for 2018.

The six-country monitoring committee, which includes Russia, Kuwait, Venezuela, Algeria and Oman, will meet again in April in Saudi Arabia, with an exact date and venue yet to be decided.

The full OPEC/non-OPEC coalition will meet June 22 in Vienna.

--Herman Wang, herman.wang@spglobal.com

--Edited by Jonathan Dart, newsdesk@spglobal.com