EXECUTIVE SUMMARY

Since OPEC end-November meeting the price has been trading above $50 per bbl.  Implementation of the deal and new promises from Saudi Arabia will be important for the price to stay above this floor. Following the agreement, OPEC had to cut its production from January 1. The price is high and only traders’ mistrust in OPEC promises does not allow it to go above last year records. While Middle East allies (Saudi Arabia, Kuwait, Qatar, U.A.E.) are announcing implementation of their parts of the cut, the market keep calm and waiting for the stats in February. Additionally, the implementation of the deal by these countries has been mostly expected. It is the other members of the organization who matters.

In other news, Russia has cut oil production in the first week of January by 100 thsd bbl / d from December levels. Surprisingly positive sign at first glance, it should not be viewed as a completely voluntarily act given extremely low temperatures (-60 Celsius) in West Siberia these days. Late last month and in early January, temperatures fell as low as minus 60 Celsius (minus 76 Fahrenheit) across Siberia, rendering metal brittle, causing power supply disruptions, halting cars’ engines and making it impossible for people to work outside in the open air, according to Reuters article.  “Usually, all the working activity is stopped when it is minus 48 (Celsius). Otherwise, you have to face the consequences,” an oilman who makes regular work trips to Western Siberia said by phone, requesting anonymity as he was not authorized to talk to the media. Russia registered one of the sharpest drops in its oil output in the winter of 2005/2006, when Siberia experienced comparable low temperatures. In January 2006, Russian production declined by 180,000 barrels per day, at the time the biggest monthly drop in seven years.  

The risks for breaking below in the nearest future are mostly from U.S. oil production recovery. According to the weekly data of U.S. Department of Energy, it has grown by about 300 thsd bbl / d to 8.77 mln bbl / d at the end of last year from September levels after OPEC first announcement of the deal in Algiers. The more oil is coming from the USA the more oil should be cut by Saudi to support the price. OPEC calculated its balance for 2017 given decline of U.S. oil production by 150 thsd bbl / d.  U.S. Energy Information Administration (EIA) expected oil production in the USA to rise by 110 thsd bbl / d to 9 mln b / d. In 2018 output is predicted to rise to 9.3 mln b / d. It is possible that the prediction from EIA is too cautious. The market is used to surprises from U.S. oil production.  For the first week of this year Department of Energy reported a surge in U.S. oil production by 176 thsd bbl / d. Petromatrix noticed that U.S. oil output is now roughly at the same level as in Nov 2014, when OPEC declared war on shale producers. According to BTU Analytics, at current rig count and rig efficiency, the Permian Basin is on a trajectory to grow almost 0.6 MMb/d in 2017. Additionally, crude oil price usually declines in the beginning of the year. Last year the Iran nuclear deal made the price to sink to record lows due to lifting the sanctions and oil production recovery from the country. This time Iran could be the factor to push prices higher.    

Upside risks for the price include Iran-USA conflict escalation after Mr. Trump’s inauguration. The future of the nuclear deal is uncertain now. The Wall Street Journal has analyzed recently the situation around the deal: “Mr. Trump attacked the deal repeatedly during the presidential campaign and has appointed critics to top positions in his administration, according to. However, Mr. Trump has only mentioned the agreement once since winning the election—describing it as a “horrible” deal in a December tweet—leading European officials to hope that he won’t tear up the accord.  The Iran nuclear deal is a politically binding agreement reached in 2015, but it was not signed by the parties. European and U.S. diplomats have expressed concerns that the agreement could unravel if the Trump administration seeks to take fresh measures against Iran, including new nonnuclear sanctions and efforts to crimp its regional influence. “ Fresh measures against Iran from Trump administration could be enough for the deal to be broken and oil embargo to be reinstalled. In that case the price will no doubt skyrocket in high $60s. 

The point of supply/demand balance in the market is close, according to energy agencies, but high storage levels put a pressure on the price. The OPEC cut is purposed to remove oversupply from crude oil inventories. EIA revised upward petroleum demand for 2016 by 140 thsd bbl / d and raised 2017 demand by 210 thsd bbl / d. Their view on demand growth in 2018 is also very optimistic. Demand is expected to grow in 2018 with the pace even higher than in 2016. Demand growth for 2016-2018 is 1.43  mln b /d, 1.63 mln b /d and 1.51 mln bbl / d or (+1.5%, +1.7% and +1.6%) year-over-year respectively.  On the other side, expectations for non-OPEC crude oil production in 2017 was raised just by 60 thsd bbl / d, with a year-over-year increase of 0.41 mln b / d (+0.7%).  In 2018 non-OPEC supply is expected to grow 0.66 mln b / d (+1.2%) to average 57.92 mln b /d. OECD total oil stocks covered 66 days of supply at the end of December. Inventory coverage was 3.3 days higher than a year ago and 8.3 days above the five-year average.

Surprisingly, EIA’s forecasts for the price of WTI in 2017-18 are not far at all from current price levels. The agency predicted $52.5 and $55.2 per bbl respectively.  Brent premium is $1 per bbl over WTI forecast.

WTI Dec17-Dec18 spread has returned to contango for the first time since OPEC end-November meeting. It looks like another sign of market’s skepticism in OPEC’s abilities to remove the oversupply in stocks.

Download PDF

18 January 2017, Arbat Capital

oil

Read more