Expert: Gradual decline in oil inventories should result in more balanced markets in 2018

By Kamila Aliyeva

Talks and rumors on possible prolongation of the OPEC+ output cut deal continue to impact the global oil market.

Crude prices jumped in May after OPEC and other major exporters extended their current deal to limit oil production for nine months, but later continued to decline as investors were anticipating deeper cuts.

Most recently, Russia and Saudi Arabia discussed the possibility of extending for a second time the oil output-cut deal between OPEC and non-OPEC producers negotiated in November 2016.

Considering Russia’s position as the world’s largest producer with almost 11 million bpd, thinking of an oil strategy confined to OPEC members alone would not be a recipe to success, UK based energy analyst Alessandro Bacci said.

Bacci underlined that defining a working strategy suitable for all the involved oil-producing countries is always very difficult.

“The common denominator among all these countries is their fiscal budget’s strong dependence on their oil revenues. But apart from this, these countries have different histories, which translate into different economic and political agendas,” he wrote in an e-mail to Azernews.

On top of this, according to him, is the difficult cooperation among OPEC members related to the intense political struggle between Saudi Arabia and Iran for regional influence.

Under the present deal, Iran obtained an exemption to slightly raise its output, which had been reduced by years of Western sanctions. In August, Iran pumped 3.82 million bpd of crude oil.

Until a few weeks ago, with still oversupplied oil markets, it seemed that a production freeze would be not very useful because OPEC production rose to 32.8 million bpd in July (highest value in 2017)—Nigeria, an OPEC member under exemption from output curbs, pumped more crude oil.

“In practice, the only valid solution was a consistent production cut, which indeed was politically very difficult to agree on,” he said.

Today, oil markets are in the process of rebalancing because finally inventories are decreasing, the expert noted, adding that markets are reentering a backwardation phase, although in a feeble manner.

“Now, the next two months and a half, which lead to OPEC’s November 30 meeting, will be crucial to understand what petroleum policy the oil-producing countries will apply after March 2018. In specific, if the present, and still in its infancy, rebalancing of the oil markets continues, it could really save oil producers from being forced to implement a production cut larger than the present one, which is 1.8 million bpd,” Bacci said.

As for the oil prices, the expert noted that considering the current possible sustained transition toward a backwardation phase, predicting where the oil prices will be in 2018 is very difficult.

Commodity price movements depend on inventories (cyclical component linked to short-term supply and demand shocks) and marginal costs (structural component linked to the long-term impact of technology, geology, and politics), according to the expert.

“When we look at 2018, we need primarily to consider the cyclical component, i.e., inventories. In this regard, the contango phase of the oil markets, which has been a constant phase since the second half of 2014 because of the crude oil oversupply, has begun to lose ground  due to an increase in the demand for prompt-loading oil barrels and in the expectations that the oil markets will rebalance over the next year. All this means, a drawdown in crude oil stocks, i.e., an inventory reduction,” he said.

“The financialization of the price of crude oil is still not entirely clear, but it has an effect because calendar spreads are able to understand better the balance between supply and demand. In addition to this, if we give more importance to futures fundamentals than to physical fundamentals, it’s evident that these expectations will be then reflected in the spot price of a specific benchmark,” he added.

Bacci believes that, under the current production levels, the gradual decline in global crude oil inventories should be able to produce more balanced oil markets in 2018, which could help maintain the current price levels, if not to produce a slight price increase as well.

“But, much depends on what oil producers will decide next November. If they prolong their crude-oil production-cut agreement, this scenario could materialize. Instead, if they look at their long-term interest (expand their market share at the expense of the U.S. shale producers) and return to maximum production, oil markets would probably go to square one, which in this case means an oversupply of crude oil,” he added.

Meanwhile, oil markets were firm on September 18 and remained near multi-month highs reached late last week as the number of U.S. rigs drilling for new production fell and refineries continued to start up after getting knocked out by Hurricane Harvey, Reuters reported.

On NYMEX (New York Mercantile Exchange) cost of the US light crude oil increased $0.07 to stand at $49.96. Price of the Brent crude oil at the London ICE (Intercontinental Exchange Futures) rose $0.07 to trade at $55.69.

The price of a barrel of Azeri Light crude oil decreased $0.25 to stand at $58.30 on the world markets also preserving quite high price level.

Last week, prices for Brent and WTI rose by more than 5 percent on optimism about the demand for oil in the U.S. as the refineries closed after Hurricane Harvey resumed and talks on extension of the OPEC agreement on production cuts continued.

In addition, the oil market was supported by positive forecasts for world oil demand from OPEC and the International Energy Agency (IEA).

The International Energy Agency analysts revised its forecast for oil demand in 2017, raising it to 1.6 million barrels per day, compared with the forecast of 1.5 million barrels per day in its July report.

This data came out one day after the OPEC report showed that last month oil production in the cartel countries fell for the first time since March. OPEC also raised the forecast for the volume of world oil demand in 2017 by 280,000 barrels per day - up to 96.77 million barrels.

OPEC and other major oil producers such as Russia, Azerbaijan, Bahrain, Brunei, Equatorial Guinea, Kazakhstan, Malaysia, Mexico, Oman, Sudan, and South Sudan reached an agreement in December 2016 to remove 1.8 million barrels a day from the market. 

The deal to curb output brought crude prices above $58 a barrel in January but they have since slipped back as the effort to drain global inventories and stabilize the oil market has taken longer than expected.

OPEC and its partners decided to extend its production cuts till March 2018 in Vienna on May 25, as the oil cartel and its allies step up their attempt to end a three-year supply glut that has savaged crude prices and the global energy industry.

---

Kamila Aliyeva is AzerNews’ staff journalist, follow her on Twitter: @Kami_Aliyeva

Follow us on Twitter @AzerNewsAz