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Oil market out of balance despite rising demand

Despite falling non-Opec supply and rising demand, the market still has a way to go

The North American rig count is trending lower again, global oil demand is gathering steam and the US’ Federal Reserve on 17 September decided not to lift interest rates. Ordinarily, each of these would be bullish for oil, yet crude markets in September remained depressed. On 22 September, Brent was down 11% on its end-August high, at $48.45/barrel.Opec is one reason. Its lynchpin Saudi Arabia has resolutely resisted pleas from Algeria and others for an emergency meeting. Non-Opec output is struggling and after years of stagnation the call on Opec’s crude is rising. The International Energy Agency (IEA) has added 200,000 b/d to the estimated call for the rest of this year and predicts it will rise by 1.6m b/d, to 31.3m, in 2016.

The group is clawing back its customers and its big producers are pumping hard to keep them. Saudi output of 10.3m b/d, although down on the month, was still the kingdom’s sixth straight month of double-digit production. It has also lowered its selling prices for crude to Asia.

Iraq’s 4.33m b/d in August was almost 400,000 b/d above its average for the year. Iran hopes to add 0.5m b/d next year and is already selling down its storage stocks. Windward, an Israeli firm that tracks Iranian floating oil levels, claims it sold 1.85m barrels alone between 18 and 22 September.

The supply numbers are feeding into prevailing bearish sentiment. China’s weakness was a factor in the Fed’s decision not to raise interest rates and remains a macro-economic headwind for all commodity prices, although the IEA takes a more optimistic view. Goldman Sachs, going further than most, reckons Brent could touch $20/b. Hedge funds have reduced some short positions, but aren’t yet betting on a sustainable price rally. The imminent start of refinery maintenance season in the US will probably justify the caution, at least in the short term.

After some buoyancy in the summer, American tight oil is creaking again too. September’s price softness brought three consecutive weeks of falling rig counts. Production is expected to contract by nearly 400,000 b/d next year, as the latest price rout takes 2016 future prices below the average breakeven cost for all major shale plays. As a result, the slump in drilling and completion rates is likely to extend well into next year – in contrast to a rebound expected previously.

Overall, non-Opec production will fall by about 0.5m b/d, predicts the IEA. Weak prices are “forcing the market to behave as it should by shutting in output and coaxing demand”, says the agency. But how quickly rising demand and falling non-Opec supply combine to drain global stocks will only be known sometime next year. OECD inventories were 2.923bn barrels in July, a record high, buoyed by a global oversupply still running at more than 1m b/d. Burning off the stored excess will take months – even if Iran’s oil comes back more slowly than the country hopes. All the while, Canadian bitumen, Brazilian pre-salt and US Gulf of Mexico projects that were planned years ago and are due on stream by 2017 will pour more oil into global supplies.

Absent a geopolitical shock, the market will only really start to clear its excess and feel balanced when the deferments to big conventional projects begin to bite. The timeline for that is probably best measured in years, not months.

Vicious volatility

The recent volatility has been unnerving. Brent crude jolted from a six-year low below $43/b to above $50 in the space of days.

The lure of $50/b oil is boosting demand growth to a five-year high of 1.7mn b/d barrels this year, the IEA’s latest forecast shows. But some forecasters think things could be starting to turn. The IEA has sharply revised upwards its forecasts. OECD consumers, especially American drivers, are leading this surge, believes the agency.

The sizeable anticipated loss of overall non-Opec output and robust demand growth suggest that unless prices recover, lower-cost Opec producers would need to turn up the taps during the second half of 2016 to keep the market in balance.

Global oil production fell nearly 0.6m b/d to 96.3m b/d in August as output fell in both Opec and non-Opec countries. Supplies nevertheless stood more than 2.4m b/d above a year earlier, with non-Opec producers making up 43% of the gain, the latest data from the IEA shows.

Opec crude supplies fell by 220,000 b/d in August to 31.57m b/d, led by losses in Saudi Arabia, Iraq and Angola but output was still 1.2m b/d higher than it was a year ago. And in July, Saudi Arabia even hit a five-year record in its crude consumption for power generation. 

Non-Opec production fell by 350,000 b/d in the same month to 58.16m b/d. The fall was led by the US, which saw accelerating declines from recent highs, and lower North Sea volumes, curbed by seasonal field maintenance. Yearly gains in total non-Opec liquids output still stood an impressive 1mn b/d above a year earlier, from an average 1.8m b/d seen since the start of the year. 

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