June 22, 2018
During the ninth meeting of the Joint Ministerial Monitoring Committee last night, the OPEC Heads of Delegation reached a preliminary agreement to increase output from the group by a nominal 1 million barrels per day.
“Our view is that there are fundamental signals within the market that show this decision is an essential move to avoid an overly tight market and potential price spike in the second half of this year,” says Bjørnar Tonhaugen, vice president of oil market research at Rystad Energy. “If no consensus is reached, Saudi Arabia and Russia will likely choose to raise output regardless, possibly in a coalition with other countries - which would also exacerbate tensions with Iran.”
1. Global oil demand will increase in 2H 2018 versus 1H 2018
By Rystad Energy’s estimates, global oil products demand in the third quarter will increase by 1.1 mmbbl/d quarter-on-quarter, owing to seasonally higher demand for transportation fuels during 3Q across the globe, increased power generation demand in the Middle East and strong NGLs demand growth in the US. Demand stays largely flat on 3Q during 4Q, supported by the ongoing global economic expansion.
2. The market will lose a significant amount of supply from Iran and Venezuela
The market will lose additional supply from Venezuela and Iran during the course of 2018. Although it is too early to know the full impact of US sanctions on Iranian production, Rystad Energy expects Iranian production to drop by ~700,000 bbl/d by December 2018, but the loss could be larger.
“There are indications that Iranian oil exports have already begun dropping during the first half of June, mostly to Europe. We also expect Venezuelan production to decline a further 150,000 bbl/d towards year-end, with risks still skewed to the downside,” says Tonhaugen.
In Rystad Energy’s view, the risk of production shortfall in fellow OPEC members Iran and Venezuela (possibly 850,000 bbl/d by year-end) and the ensuing risk of a price spike in the near term, causing “consumer anxiety”, is the most important reason underpinning the shift in Saudi Arabia’s policy stance since mid-May.
3. US production growth is limited by takeaway constraints in the Permian
The growth from US shale will be limited to 100,000-150,000 bbl/d per month at current oil prices and differentials, owing mostly to pipeline takeaway constraints in the Permian.
“Our latest shale activity data suggests fracking activity will stay largely flat in the Permian from April towards year-end, but production will grow robustly,” says Artem Abramov, vice president of shale research at Rystad Energy.
Therefore, in the current market where the combined effect of demand growth and supply shortfalls is in the magnitude of 2 mmbbl/d, OPEC is again the only effective swing producer.
4. The risk for new unplanned supply disruptions (eg. Libya) would exacerbate the already tight global oil market situation
The risk of unplanned supply disruptions is on the rise, exemplified by the resumption of outages in Nigeria in May 2018 (Forcados, Bonny Light) and last week in Libya where the Ras Lanuf and Es Sider ports were shut due to rebel attacks causing a production loss of 400,000 bbl/d.
“With the oil market already in a 720,000 bbl/d deficit for 2Q before the Libya outage, the tightness already apparent in the market gives any outage greater significance and potential market sway,” Tonhaugen says.
5. OPEC + Non-OPEC have over-complied with the target cuts to date
Lastly, as an argument for raising the production targets, OPEC and the 10 participating non-OPEC producers can claim to have over-complied with the target cuts to date. When calculating compliance with the cut agreement “smartly” by excluding OPEC members Libya and Nigeria from the calculations, the 12 remaining OPEC countries and the 10 participating non-OPEC countries produced nearly 800,000 bbl/d below the cut targets in May 2018.
“The over-compliance has largely been helped by declines in Venezuela and Mexico, although Saudi Arabia has also cut 80,000 bbl/d more than required to date (January 2017 through May 2018) while Kazakhstan has increased its production by 70,000 bbl/d on average as Kashagan has ramped-up,” Tonhaugen says.
The 12 OPEC countries (OPEC-12) have on average cut production by 250,000 bbl/d more than the agreed cut target of 1.159 mmbbl/d to date (January 2017 through May 2018). The 10 non-OPEC countries have cut production by less than their pledge, by 410,000 bbl/d on average versus their target of 546,000 bbl/d. Kazakhstan has increased production by 70,000 bbl/d on average as Kashagan has ramped-up, while Mexican production has averaged 76,000 bbl/d below its target cut of 100,000 bbl/d to date (January 2017 through May 2018).
OPEC has valid fundamental arguments for raising production to avoid an overly tight oil market in the second half of 2018 leading to a potential price spike. Last night (June 21), the Joint Ministerial Monitoring Committee reached a preliminary agreement to increase production by a nominal 1 million barrels per day, despite opposition from the Iranian delegation. The proposal would effectively raise production by 600,000 bbl/d as countries like Venezuela and Mexico are unable to increase output. Such an increase is warranted by our supply-demand balances, which incorporated a 500,000 bbl/d increase by Saudi Arabia and Russia.
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