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Oil through the worse?

Opec cut, shale grew, stocks fell, demand soared, prices rose and balance—the oil market's magic word—drew near

The year started with gloom about the never-ending oil glut. It ended with forecasts for surging prices and an imminent rebalancing.

That last word—rebalancing—was ubiquitous in 2017. Everyone wanted it. Many predicted it. Opec obsessed about it, and found a metric to measure its progress: OECD stocks. Taming that beast, by bringing the inventory back down to the five-year average, was the group's goal. They had some success. In January, the surplus stood at 318m barrels; in October, 170m.

Supply management was a crucial force. For oil markets, 2017 began on 10 December 2016, when Opec and a host of other producers, led by Russia, agreed to cut 1.8m barrels a day from supply.

Doubts followed immediately. The cutters had opened the taps in the run-up to the deal, maxing out before the quotas took effect at the start of 2017. Few expected Moscow to honour its pledge. But deliver Russia did; by October it had slightly exceeded the 300,000 b/d it promised to remove.

Opec's performance was surprising. Thanks to heavier-than-promised cutting from Saudi Arabia and involuntary output losses in Venezuela, compliance with quotas through the year was tighter than after any previous Opec deal. Despite the rivalries within the group—and in 2017, these surfaced across the Gulf—producers largely toed their quota line.

Some help arrived from America. Resilient as the country's tight oil producers proved to be, output didn't bounce quite as high in 2017 as some predicted. After falling in 2016, oil production rose—the Department of Energy expected it to end the year at 9.3m b/d. But that addition, of 385,000 b/d, didn't overwhelm global balances, even if US stocks remained high and American exports grew steadily.

Demand did its share of the rebalancing too, especially in the year's second half. In December, the International Energy Agency had predicted the world would consume 1.3m b/d more oil in 2017. By October, its number was 1.6m. Cheap oil even perked up areas the oil market had largely written off, like Europe. Fuel consumption in the US roared ahead. Stories of drivers swapping their battery vehicles for gas-guzzlers did the rounds. For veteran oil watchers, this was no surprise. Oil was just going through another turn of its ageless cycle, and economic laws of supply and demand were doing their thing.

Clearly, consumers hadn't read the memo about oil's demise. Their renewed thirst sat awkwardly with the industry's other fixation in 2017: the onset of electric vehicles. Better batteries, longer ranges, cheaper models—a week didn't pass without news of oil's big threat. The industry suffered some cognitive dissonance.

No major could ignore the phenomenon in its forecast. All fretted over its impact. Few endorsed the change. Shell came closest, saying it would roll out charging points in Europe after buying a provider. Its boss, Ben van Beurden, said his next car would be electric.

But older forces—like weather and politics—were behind the market's shift as the year wore on. The move looked unmistakably bullish: the six-month futures curve changed from contango to backwardation. The rally started in the summer, when reports surfaced that Saudi Arabia would start cutting exports, especially to the US, and not just production. It gained steam in August when hurricanes temporarily knocked out some Gulf of Mexico production.

The tailwind behind prices strengthened after Iraqi Kurdistan's fated independence referendum in September. Within weeks, Iraqi federal forces had advanced to the region and recaptured all territory Kurdish Peshmerga had gained since 2014. Kurdish dreams of independence were quashed. Control over its oil sector was lost. Exports from northern Iraq ceased, then resumed, then their volume bumped up and down.

In November came Mohammed bin Salman's purges in Saudi Arabia: a startling consolidation of power. Houthi rebels fired a missile towards Riyadh airport. The kingdom seemed to go on a war footing, accusing Iran and even Hezbollah of orchestrating the attack. Oil prices rose towards $65/b. The geopolitical-risk premium, it seemed, was back.

It was part of a marked shift in sentiment. By Q4, many banks had raised their price forecasts for 2018. The talk was of a "supply gap", as demand outpaced the production available from an industry still nervous about spending money. Wall Street had tired of bankrolling tight oil's profligates, said some. No sooner had the phrase "lower for longer" become an industry cliché than the price seemed to be climbing out of its trough.

But dangers were visible. As the November 2017 Opec meeting neared, the market baked in an extension to the cuts. It seemed probable—and probably necessary—for the group to keep cutting. But it wasn't a dead cert and nor was another year of quota discipline. By late 2017, Russia, Kazakhstan, Iraq and others in the deal were already talking of more output next year. Shale oil producers, after putting their businesses on a more stable footing, seemed to be poised, awaiting the right price signal. The tighter, jumpier market of late 2017, and forecasts of $70 oil, came with flashing neon lights.

This article is part of Outlook 2018, our annual book looking at energy market trends for the year ahead. To purchase a copy, click here

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