What to consider when analyzing the oil markets
The Organization of the Petroleum Exporting Countries (OPEC) will meet on May 25 in Vienna and in all likelihood extend the production cuts of 1.2 million barrels per day (bpd) until the next meeting in winter, if not into 2018.
So much was clear from statements of several OPEC ministers over the last two weeks. Russia also looks set to spearhead the non-OPEC part of the deal. This is not surprising: The overall output cut deal has brought billions of dollars of increased revenue to Russian oil companies and the state coffers alike. A production cut of 300,000 bpd is negligible given that Russia’s daily production exceeds 10 million barrels.
Why then have we seen such a roller-coaster ride in oil prices? Brent spiked above $60 a barrel in January, reflecting the market’s general euphoria with the strong compliance (of over 94 percent for OPEC members) with the output-cut deal. Markets calmed and we saw the benchmark Brent trading in a comfortable level of between $50-$55 per barrel — broadly in line with the ups and downs of the US and Chinese economic data and US stock inventories.
Then something extraordinary happened when markets saw the US Energy Information Administration (EIA) statistics for the week ending April 28: US crude inventories had fallen by only 900,000 barrels, which was well below expectations and sent oil prices into a tailspin. Both Brent and West Texas Intermediate (WTI) ended well below $50. But then on May 10, a rally was triggered by a bigger-than-anticipated US stock draw of 5.2 million barrels, combined with repeated assurances of some OPEC countries as well as Russia that the output deal was likely to be rolled over. The steepest intra-day oil price rally of this year brought Brent again above $50.
What to look out for
Commodity markets are generally volatile. Traders like and need volatility. Indeed, it is their lifeblood. It is the job of the analysts to investigate and query what lies behind the numbers.
First of all, we should be looking at the big macro trends: OPEC, the International Energy Agency (IEA) and the US Energy Information Administration (EIA) all agree that markets should be balancing within the second half of the year. Production may increase by more than the 500,000 bpd, which was the April consensus estimate. Still, we shall see demand growth of around 1.3 million bpd outpace supply growth by at least 500,000 bpd.
Analysts generally focus too much on US stocks — but the world oil market is more complex than one data-point alone.
Analysts generally focus too much on US stocks, while this is an important data point, it does not give the full picture. We also need to look at inventories in China — although Chinese inventory data does lack some transparency — along with those of Iran, the Gulf and India. One should also not overreact when looking at first-quarter stock levels in the US, given this time of year is when we have historically seen inventories build, as refineries go into their maintenance schedules. In other words, the world oil market is more complex than one data point alone.
Rising oil prices brought the shale space back with fervor. In April, the US produced more than 9 million bpd — a volume not seen since August 2015. Shale production has increased by about 800,000 bpd since the beginning of 2017. Production increases in the shale space are geographically limited and further production increases may not be limitless. Whereas it is true that Big Oil has put $25 billion into the Permian Basin this year alone, we should look at the context: Shale production may have to make up for constraints in conventional production down the line.
According to the IEA, the international oil majors slashed planned investments in conventional oil by 24 percent in 2015 and 26 percent in 2016. The international big oil companies will need a rapid response mechanism — shale — to be ready to produce more oil when demand picks up. Shale investments will produce oil within six to 18 months. Production from new conventional projects is bound to ebb by the early 2020s, given the current investment levels. One dollar invested in conventional oil today will produce a barrel in three years at the earliest — more likely in seven to 10 years.
Lastly, we should also look at the changing quality of oil produced in North America. Refineries are currently geared toward processing heavier crudes. Shale oil is lighter. Accommodating the ever-increasing shale production will, therefore, necessitate major investments in refineries.
I am always amused when I see pundits giving sweeping statements on selective facts. The oil space is complex and we need to look at the intricacies on the demand as well as the supply side.
• Cornelia Meyer is a business consultant, macro-economist and energy expert. She can be reached on Twitter @MeyerResources