The global crude oil market quickly flipped from being short crude in 2014 to long in 2015 as oil production sky rocketed and global demand failed to keep pace. Despite a severe price crash in crude, production was slow to respond and we entered a period of significant global oversupply and price volatility. As the supply overhang and low prices threaten to linger into 2017 and beyond, OPEC has returned to the table to discuss the prospect of an oil cut after an initial round of failed attempts to freeze output. In fact, since initial discussions in November 2014, when prices started to spiral, OPEC oil production has grown 2.8 MMb/d.
However, on September 28, OPEC revealed a change of rhetoric when they announced that they would work toward a formal agreement to cut production from its current estimated levels of 33.26 MMb/d by roughly 700 Mb/d to maintain crude production targets ranging from 32.5 MMb/d to 33 MMb/d. While this deal is far from being inked, 2017 average Brent prices have responded and risen by over $4/Bbl between September 27 (day before OPEC announcement) and October 3.
While we remain skeptical that OPEC will follow through on its announcement to cut production, BTU Analytics decided to run two different scenarios using IEA production data, BTU Analytics US and Canadian production forecasts, and IEA refining demand. In the first scenario, we assume that OPEC is able to reach an accord and cuts production by 700 Mb/d in January 2017. In the second case, OPEC members agree to freeze production at current levels and no production cuts are implemented.
In the first case, the global surplus of oil could be worked off between late 2017 and early 2018. In the second case, if OPEC is only able to freeze production at its current level of 33.26 MMb/d the supply overhang would be expected to remain well into 2018. Both cases still point to volatility and limited near-term upside to crude prices. The chart below shows a cumulative shortage/surplus of global crude based on monthly supply/demand imbalances. In an ideal world, the market should be perfectly balanced and cumulative surplus/shortage is equal to zero. However, due to varying data quality for global refining and production reporting as well as storage, there is an error band of roughly 500 Mb/d (indicated in yellow) for these figures.
A few factors that could significantly impact these scenarios include: refining demand forecast revisions, the amount of crude added to petroleum storage reserves in 2016, and stability in Nigeria and Libya. There is limited transparency on data regarding storage activity in China and India, but it has been widely reported, and estimates show, that both were adding to their strategic reserves in 2015/2016, which means that some of the estimated global surplus is crude that was put into strategic petroleum reserves and will not return to the market based solely on storage economics. JP Morgan estimated that between January and May of 2016 China alone purchased 1,200 Mb/d of crude to put into strategic reserves.
Cease fire agreements and stability in Nigeria and Libya also provide significant risks to crude price recovery whether or not OPEC reaches any type of agreement. Both OPEC nations have been facing civil war which has impacted regional oil production. While it is unclear how much infrastructure damage has occurred, as recently as fall 2014 Libyan production rebounded by over 500 Mb/d in three months to 930 Mb/d. If this is used as the benchmark for a potential recovery in Libya, then there is over 600 Mb/d of incremental Libyan production today that is on the sidelines that could return to the market. Furthermore, Nigeria is currently only producing 1.9 MMb/d, which is almost 400 Mb/d lower than the beginning of 2016 and 450 Mb/d below the 2014 average.
If either or both of these nations are able to negotiate cease fires and return production to recent historical levels, crude prices could stay lower for much longer, despite any potential coordinated OPEC action.