OPEC has finally acknowledged what everybody else had concluded some time ago: U.S. shale output is soaring.
In its March Oil Market Report, OPEC revised up its forecast of non-OPEC supply for 2018 by 280,000 bpd, a major revision. That equates to year-on-year growth of 1.66 million barrels per day (mb/d).
The group couched the change in boring technical jargon, noting that “the upward revision is mainly due to higher-than-expected output in 1Q18 by 360 tb/d in OECD (Americas and Europe), FSU and China.” But make no mistake, OPEC is conceding that U.S. shale is surging, which complicates the cartel’s calculations for rebalancing the oil market.
Crucially, the forecast now acknowledges that oil supply will outpace demand this year, a conclusion that the IEA had been predicting for a few months.
The trend is worrying for OPEC. The effects of the production cuts of 1.2 mb/d (plus nearly 0.6 mb/d from Russia and other minor partners) had little effect in early 2017, likely because of the ramp up in production and exports just prior to the implementation of the deal.
However, as 2017 wore on, the cuts started to really bite. Inventories plunged toward the end of last year, tightening the market and forcing up oil prices. Some analysts have even predicted that the oil market could already be rebalanced.
The IEA was an early spoilsport, however, predicting at the start of 2018 that despite the run up in prices, inventories would start climbing again in the first half of the year. In January, oil traders shrugged off this bearish assessment, driving Brent up to $70. From there, the rally stalled, and U.S. shale began to take off again, pushing prices back down.
In subsequent weeks, the forecasts for U.S. shale growth have been ratcheted up leaps and bounds, and the expected strong gains in output from shale have transformed into expectations of a tidal wave of new supply that will push U.S. production over 11 mb/d by the end of this year. Most analysts have since followed in the IEA’s footsteps and offered their own takes on how fast U.S. shale would grow.
OPEC is just getting around to acknowledging this fact. OPEC now says that global oil demand will rise by 1.6 mb/d this year, which will be more than offset by a global supply increase of 1.66 mb/d. Ultimately, this means that a little less OPEC production will be needed. The group revised down the need for its production by 200,000 bpd for 2018.
This complicates things for OPEC, but for now, the group will stay the course. OPEC’s report pointed to the sharp decline in inventories since last year. “It should be noted that the overhang has been reduced by 289 mb from January 2017,” OPEC wrote. OECD crude inventories are only 74 million barrels above the five-year average while refined product stocks are actually in a 24-million-barrel deficit relative to the seasonal norm. This suggests that the OPEC cuts have had a huge impact.
Nevertheless, as expected, inventories have begun climbing again. OPEC noted the 13.7-million-barrel increase in stocks in January, the first increase in five months. If inventories continue to rise, even at a slow rate, the goal of bringing stocks back to the five-year average will remain elusive. All the while U.S. shale is surging, taking market share away from the cartel.
While there is speculation about what that might mean for the resolve of OPEC membersin regards to the production limits, a more immediate response could come in the form of altering the overall metric used to define success. Reuters reports that Saudi oil minister Khalid al-Falih is looking at other measurements that could guide the OPEC cuts, such as non-OECD inventories, floating storage, and oil that is in transit. The problem with that is OECD inventories have always been the main metric precisely because that offers the best available data. Data on oil stocks in non-OECD countries is tricky and opaque.
Another metric looks more promising: days of forward cover. This measures the amount of oil in storage relative to how many days that supply could cover. Because demand has climbed substantially over the last few years, the world needs more oil in storage than it used to.
For instance, OECD commercial stocks held 60 days’ worth of global demand in January, which is actually 5.3 days below the same period a year ago. Crucially, it is 0.6 days of cover lower than the five-year average – in other words, the oil market is balanced according to this measurement.
It’s not clear how this will inform OPEC’s decision-making; U.S. shale is still surging, keeping a lid on oil prices, regardless of the metric OPEC wants to use. If OPEC were to declare victory and return to full production, oil prices would likely fall sharply. “OPEC and Russia would probably be better off signaling a gradual approach or a ‘tapering’ of sorts,” said analysts at Bank of America-Merrill Lynch.
Indeed, the recognition that U.S. shale is going to grow more than expected likely means that OPEC realizes it will need to keep the cuts in place longer than it had planned.