EXECUTIVE SUMMARY

In November 2016 the crude oil market returned to above $50 per bbl levels on agreement among OPEC members to cut production in the first half of 2017 to a target of about 32.7 mln bbl / d. The deal was made possible by Saudi Arabia’s willingness to support the market at almost any costs. Iran was granted higher quote than its oil production level in October according to second sources. Russia officially pledged to cut by 300 thsd bbl / d, but gradually from record production numbers in November or even December. It seems, for Russia, as for other non-OPEC countries, the cut is nothing more than natural production decline, which was apparently accepted by Saudi Arabia.

Deterioration of market’s fundamentals in recent months must have made Saudi Arabia to easy its requirements for the rivals. Higher production in Libya and Nigeria and possible weak demand in China next year are mostly the risks for the price. Traders with short futures positions in the market didn’t look any more as concern of OPEC verbal interventions in November as they had before in 2016. Prior to the OPEC meeting on November 30, Saudi Arabia had been persuaded to act by invited to Vienna traders from trading companies, like Vitol, and hedge funds, according to Financial Times. Obviously, Saudi’s minister had been convinced that without announcement of the promised deal the price would crush below $40 per bbl.

Our base-case scenario for the OPEC meeting outcome was about a half of the promised cut to support crude oil price in its trading range from May ($40 - $50 per bbl). The full commitment from OPEC was a surprise for the market too and the price went to new highs, but stopped eventually after getting to $55 per bbl level. Even a surprising attempt to reassure the market from Saudi Arabia by promising more cuts (below psychological 10 mln bbl / d) didn’t work as expected. Positive effect was short-lived and the price is still not far from $50 per bbl.

Waiting for the actual cuts in January, the market remains skeptic. Supply/Demand forecasts by energy agencies have very different outcomes given OPEC/non-OPEC commitment to cut. IEA prediction looks overwhelmingly optimistic: oil stockpiles decline by about 600 thsd bbl / d in the first half of 2017 as curbs by OPEC and its partners take effect. “Before the agreement among producers, our demand and supply numbers suggested that the market would re-balance by the end of 2017,” the Paris-based agency said in its monthly market report. “If OPEC promptly and fully sticks to its production target” and other producers cut as agreed, “the market is likely to move into deficit in the first half of 2017.” Oil stockpiles will decline by about 600,000 barrels a day in the next six months as curbs by OPEC and its partners take effect, said the agency, which had previously assumed inventories wouldn’t drop until the end of 2017.

The most surprising thing, IEA is looking very positive on oil demand from Russia and China. The agency increased its forecast for global oil demand in 2017 by 100,000 barrels a day. Consumption will rise by 1.3 million barrels a day, or 1.4 percent, to 97.6 million a day: “Following revisions to Chinese and Russian data, we have raised our 2016 global net demand growth number to 1.4 mbd and that for 2017 to 1.3 mbd.”

However, there are significant risks for China demand next year:

-       According to consulting agency Energy Aspect, China may lower its program for fulfilling Strategic Petroleum Reserves by 100 thsd bbl / d when the price is above $50 per bbl.

-       Tightening regulation for Chinese teapot refineries may curb oil demand by 400 thsd bbl / d.

-       Possibility of trade wars between China and the USA.

The import of crude oil to China in November reached 32.35 mln metric tons (equals to 7.9 mln b / d) according to China's General Administration of customs, pretty high level. But the data do not look so bright taking into consideration the fact that no less than 15% of imported crude oil nowadays China forwards to its SPR. So any delays or temporary suspensions of reserve accumulation process in China may result in significant drop of Chinese demand for crude oil.  Chinese interest to SUV vehicles was encouraged by retail gasoline price fall in 2015 and still has stood at rather high levels. This year each month Chinese citizens bought another roughly 600 thsd of SUVs, so the total amount of these gas-guzzlers in China grows at a very rapid pace. In November number of sold of SUVs in China surged above 1000, possibly another positive signal for IEA to look more positively in 2017.

OECD commercial inventories fell in October for the 3rd month in a row. They have drawn 75mb since record high in July. Global oil demand growth of 1.4 mbd is foreseen for 2016, 120 kb/d above previous forecast.  The stockpile declines will only occur if OPEC reduces supply enough to meet and maintain a target of about 32.7 million barrels a day, the agency said. The organization pumped a record 34.2 million a day in November, according to the IEA. According to Bloomberg Energy assessments in November 2016 total crude oil stocks stored on floating storages (including oil in transportation) was equal to 148.6 mln bbl, 37.3 mln bbl less than in October 2016 (-20.1% mom) and 7.8 mln bbl above the level a year ago (+5.5% yoy).

OPEC’s deal deteriorated contango in oil futures. In particular, 12-months futures to spot spread in Brent crude oil had been decreased by $1.1 per bbl to $4.9 per bbl by the end of November. After the deal it fell to about $3 per bbl, the lowest level from September 2014. U.S. oil producers are believed to hedge actively its production for 2017-2019, putting pressure on the futures curve. Lowering contango is also easily explained by the temporarily effect of OPEC and non-OPEC commitments to cut production. The time of the deal is limited by the first half of 2017. Production ceiling in the second half will be discussed further.   

The futures curve illustrates how OPEC short-term support puts some limit on oil price growth potential in the mid-term. Had Saudi Arabia been stronger and stricter in its strategy, the negative effect of low prices on U.S. shale and other high cost producers could have been much more extensive. Saudi Arabia is believed to be satisfied with lower oil production pace of growth in the USA after some negative effect of last two years (+0.5…0.6 mln bbl / d instead of +1...1.2 mln bbl / d).  It is yet to be seen.   

Download PDF

30 December 2016, Arbat Capital

Read more