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How Tight Is Global Crude Oil Supply?

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Includes: BNO, DBO, DNO, DRIP, DTO, GUSH, IEO, NDP, OIL, OILK, OILX, OLEM, OLO, PXE, SCO, SZO, UCO, USL, USO, XOP
by: Richard Zeits
Summary

OPEC's latest report suggests that the market for crude will be undersupplied by ~0.4 million barrels per day in 2018.

However, the forecast appears based on the assumption of anemic production growth in the U.S.

OPEC's forecast appears to be in strong disagreement with the EIA's forecast.

In its latest monthly assessment of the global petroleum market, OPEC's think tank reduced its "call on OPEC" estimate in 2018 by 0.2 million barrels a day ("MMb/d") from the month-earlier report. Still, the new estimate of 32.6 MMb/d exceeds the cartel's current production by a wide margin, approximately 0.4 MMb/d.

In the context of the Cooperation Agreement that has been extended through year-end, the forecast implies that the global petroleum market will be tight in 2018 and global inventories are likely to decline. The report appears to support the thesis for stronger oil prices throughout 2018.

However, similar to previous reports, the prediction is based on certain debatable premises. The forecast continues to reflect an overly pessimistic, in OIL ANALYTICS' assessment, view of U.S. oil production growth in 2018. OPEC's estimate for U.S. crude oil production falls far behind the most recent forecast by the EIA.

The "shale skepticism" persistently reflected in OPEC's forecast puts its key predictions in question and raises concerns regarding a potential bias.

OPEC Forecast: Global Supply And Demand

In its latest forecast, OPEC estimates world oil demand to increase by 1.6 MMb/d in 2018, little change from one month ago. The estimate puts 2018 global demand growth at par with demand growth in 2017, which is now estimated at 1.6 MMb/d. Total oil demand is expected to be 98.6 MMb/d in 2018.

On the supply side, non-OPEC supply forecast for 2018 was revised up by 0.28 MMb/d, "mainly due to higher-than-expected output in 1Q18 by 0.36 MMb/d in OECD (Americas and Europe), FSU and China." This upward supply revision follows an upward revision of 0.32 MMb/d a month ago when OPEC increased its expectations for production in the US, UK and Brazil, as well as reduced its decline estimates for Mexico and China. The new forecast calls for non-OPEC supply growth of 1.7 MMb/d in 2018 to a total of 59.5 MMb/d.

"Call on OPEC" in 2018 Revised Lower

The "call on OPEC" estimate for 2018 was updated and is now predicted to be 32.6 MMb/d, down from 32.9 MMb/d a month ago.

By comparison, based on secondary sources, OPEC's crude production in February 2018 declined to 32.19 MMb/d from 32.26 MMb/d in January, driven in great part by another big drop in Venezuela's volumes.

OPEC's Forecast For U.S. Production Puzzles

OPEC revised its U.S. crude production forecast up by 0.14 MMb/d from the previous report. The new forecast calls for U.S. volumes to average 10.36 MMb/d in 2018.

OPEC anticipates that U.S. crude oil production will grow by 0.52 MMb/d from December 2017 to December 2018, mostly driven by shale. Annual production growth in the Gulf of Mexico is forecast to be offset by declines in mature conventional oil fields.

(Source: OPEC, March 2018)

By comparison, OPEC's previous forecast (shown below) predicted U.S. crude volumes to reach an inflection point in mid-2018 and decline during the second half of 2018.

(Source: OPEC, March 2018)

The new forecast (the dark blue line on Graph 5-12) is less radical in the sense that it predicts a more or less consistent, albeit surprisingly slow, growth in U.S. crude volumes throughout the year.

However, the forecast remains quite extreme as it is predicting a 2018 exit rate for U.S. production below 10.5 MMb/d. To put this estimate in perspective, the EIA's latest STEO forecast predicts U.S. production to reach 11.25 MMb/d in December 2018, a ~0.7 MMb/d divergence versus OPEC's forecast. On a full-year basis, the EIA's forecast calls for average production of 10.7 MMb/d in 2018, which is ~340,000 b/d above OPEC's forecast.

The greatest difference between the two forecasts is in the predicted pace of growth.

We must note that the EIA's model was too conservative in 2017 and failed to anticipate the rapid ramp-up in U.S. production volumes during the second half of the year. However, the agency's forecast has since evolved to recognize the strong production momentum gained by the U.S. shale oil industry in 2017. OPEC, on the other hand, is apparently insisting that such growth momentum cannot be sustained.

The two forecasts are particularly divergent given their respective implications for oil prices.

In a tight market predicted by OPEC's forecast, oil prices are likely to remain firm and could potentially strengthen from their current levels. Stronger prices would be a stimulus for further activity expansion in U.S. shales (as one can derive from recent rig count dynamics) and higher production.

By contrast, the EIA's model is based on a scenario where oil prices retreat to ~$56 per barrel by mid-2018 and remain flat at that level for the remainder of the year. Such a price scenario implies a headwind for activity expansion in the second half of 2018. It would also be hardly consistent with a tight and tightening market for crude.

In terms of individual components, OPEC's report predicts solid exit-to-exit growth in the Permian but modest growth across other unconventional oil plays.

  • Production from shale and tight plays in the Permian Basin (Texas and New Mexico) is projected to grow by 0.72 MMb/d year-on-year to average 2.57 MMb/d in 2018. This represents a 0.11 MMb/d upward revision of the previous estimate.
  • 2018 production forecast for Bakken shows 1.16 MMb/d, which compares to the play's January production of 1.12 MMb/d.
  • Production of tight crude from the Eagle Ford, Niobrara and other shale plays, particularly STACK/SCOOP, is forecast to grow year-on-year by 0.09 MMb/d, 0.06 MMb/d and 0.08 MMb/d to average 1.20 MMb/d, 0.39 MMb/d and 0.41 MMb/d, respectively.

(Source: OPEC, March 2018)

How Tight Is The Market For Oil?

As before, OPEC's report implies a price-favorable outlook for the supply/demand balance for crude oil in 2018. However, the construct appears fragile.

To illustrate, we replace the estimate for U.S. production in OPEC's forecast with that from the EIA's STEO model. The supply/demand outlook becomes a lot less tight. In fact, the market looks balanced or even slightly over-supplied in 2018.

Furthermore, we must note that the balance in the crude market is hinged on OPEC leaders' commitment to restrain their production growth.

In this context, the report raises concerns with regard to OPEC's eventual exit from the Cooperation Agreement. One can envision scenarios where a material increase in volumes by OPEC following the expiration of the Agreement leads to a collapse in oil prices. As a result, it is likely that OPEC leaders will have to continue to sponsor price control measures beyond 2018 in the face of the industry's cyclical recovery and continued market share gain by North American producers.

In Conclusion...

Goes without saying that U.S. production is not the only uncertainty that will impact prices and supply/demand balance in the crude oil market this year. The actual pace of global demand growth, inventory policy by customers in Asia, supply discipline within OPEC, production trends in countries like Russia and Venezuela, and political risks in unstable regions all will contribute to the ultimate outcome. However, OPEC's favorable forecast the way it is constructed fails to convey confidence that the market will end up materially undersupplied, particularly if the futures curve holds.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.