Oil in 2017: A story of two halves
If next year is expected to be the “year of rebalancing”, as UAE Energy Minister Suhail Al-Mazrouei called it last week in Vienna, this year should be called the year of “unfinished success.”
Why so? It is because OPEC and its non-OPEC allies have successfully formed an alliance and signed a pact that protects the interests of the oil industry and producers worldwide for the first time. It is due to the efforts of the 24 countries in the pact that the oil market is now on a steady course for recovery.
But the goal of the agreement — lowering global oil stocks to a five-year average — has not been met yet despite the implementation of the agreement. Its success is unfinished.
This agreement looked like failing at many points in the year. The market changed course only in the second half of the year, after a very disappointing first half in which oil inventories rose and no one believed that OPEC and its allies would be able to meet the goal of the pact.
How did the oil market get back on track? The turning point in the agreement was the July meeting in Russia of the Joint Ministerial Monitoring Committee (JMMC).
But before discussing the second half of the year, it is important to look at the developments of the first half.
OPEC and non-OPEC came to an agreement in December 2016 to cut 1.8 million barrels of their daily production for six months (with an option to extend it for another six months) to bring down global oil inventories to the five-year average (2011-2016), which is the acceptable level of balanced inventories in the industry.
The problem with measuring global inventories is that not all of the inventories are visible. Only the inventories in member countries of the Organization for Economic Cooperation and Development (OECD) are reported accurately on a monthly basis. So OPEC and its allies (also known as OPEC+) decided to use the OECD stocks as their reference. At the beginning of this year, OECD stocks were at 340 million barrels above the five-year average.
OPEC+ thought that lowering OECD stocks should not be a big problem. Cutting 1.8 million barrels a day means 54 million barrels a month, so it would take six months to lower the stocks by 324 million barrels. An ideal situation, but only on paper.
With a high level of confidence and an initial calculation, Saudi energy minister Khalid Al-Falih announced during the CERAWeek conference in Houston that OPEC+ might not need to extend the agreement beyond June. It was at this moment that the market started to panic as no one was sure when stock would normalize.
During the first half of the year negative developments took place that delayed the market recovery.
First, demand was slower than expected in the first quarter.
Second, OPEC+ increased exports and production in the fourth quarter of 2016 to record levels and they again raised exports in the first quarter of 2017. The effect of that was more stock build-ups.
Third, production of tight oil (better known as shale oil) increased in the US, putting pressure on prices and leading to more supply in the market.
Fourth, the compliance of producers was not as great in the first few months of the year as in the second half. In January, compliance of OPEC+ was reported at 86 percent. This increased to 120 percent in October.
Last but not least, there was a supply shock from Libya and Nigeria who managed for a short time around mid-year to ramp up production collectively by one million barrels a day.
In these circumstances, OPEC+ had to extend the deal another nine months (until March 2018) when they met in May as the market was still weak and rebalancing stocks was a moving average.
It was not until July that OPEC+ took a real stand against the situation. A Saudi energy minister who had a strict approach toward low-performing members of the deal during the JMMC meeting in Russia said that he would lose credibility in the market because of the inability of OPEC+ to deliver its goal.
Saudi Arabia in the second half invested a lot of political capital to make countries conform better to the pact. The country also lowered unilaterally its production and exports more than required to lead by example, and in few month’s time the drawdown in stocks was clear as shale oil and Libyan and Nigerian output slowed.
Hard work alone, however, is not enough and nature intervened. Thanks to two hurricanes (Harvey and Irma), production of oil in the US fell and refineries in the Gulf of Mexico closed down. This led to an increase in refining margins due to a shortage in products and this improved demand for crude oil globally. Thus, oil demand in 2017 grew by its highest in 10 years, at around 1.5 million barrels a day.
So, after almost a year of the deal, OECD oil inventories overhang is down by 200 million barrels a day. What OPEC+ needs to do is to steady the course and hope that oil demand in 2018 will be as strong as this year.
• Wael Mahdi is an energy reporter specializing on OPEC and a co-author of “OPEC in a Shale Oil World: Where to Next?” He can be reached on Twitter @waelmahdi
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