Next year likely will see global oil demand expand again by 1.5 million barrels per day and US supply rise by 870,000 barrels per day – although Opec likely will at best maintain the cuts implemented in 2017, resulting in a balanced market, a report said.
On these assumptions, Brent crude should average $56 per barrel in 2018 and hit a high point of $70 per barrel at the peak of the US driving season, added the Bank of America Merrill Lynch (BofAML) 2018 Energy Outlook.
Brent to average $56 in 2018
The global oil market experienced a clear turning point in 2017, with balances tightening on the back of robust 1.5 million barrels per day (b/d) growth in demand and an Opec/non-Opec supply cut deal of 1.8 million b/d. As a result, the global oil market may register a 230,000 b/d deficit in 2017. The picture for 2018 has some similarities and some differences. On the one hand, global oil demand will likely expand again by 1.5 million b/d and US supply may rise by 870,000 b/d, compared to 500,000 b/d in 2017.
“On the other, Opec will likely at best maintain the cuts implemented in 2017, so we see a balanced market. Still, we expect Saudi Arabia and Russia to engineer an extension of the output cut deal through the end of 2018, and also to lay out a clear ‘exit strategy’ before 2Q2018,” the report said.
Global crude oil prices, particularly Brent, have firmed up more than we expected and we see Brent crude oil averaging $60 in 4Q17 and $56.50/bbl in 1H 18, compared our previous forecasts of $54 and $52.50/bbl, respectively.
“We also adjust WTI to average $54 this quarter and $52.50/bbl in 1H18E, against previous forecasts of $49 and $48.50/bbl, respectively. Our revised global oil supply and demand forecasts point to a sizeable deficit in 2017 of -230 thousand b/d and a more balanced market in 2018. Our projections also reflect the idea that global oil markets are more balanced than the US crude market,” BofAML said in the report.
Iraq, the second largest producer within Opec, seems the more imminent geopolitical concern to the oil market. Production at two disputed fields in Kirkuk (280,000 b/d) completely collapsed as Baghdad took over control of the assets from the Kurdistan government, which had been in charge of the area since 2014.
While oil field disruptions are likely to be temporary, shipments through the Kurdish export pipeline, which normally pumps 600,000 b/d of oil mainly from Kirkuk as well as fields in Northern Kurdistan to Turkey's Ceyhan port, remains at around 200,000-300,000 b/d. Even then, given the existing Opec cuts, we would expect Iraq to make up some of the volumes through increased exports from Southern fields to the port of Basrah.
Crude output has increased to 3.8 million b/d since the oil sanctions were lifted, while exports are now as high as 2.2 million b/d. So the risk of a geopolitical disruption in Iran led by a more combative US stance is considerable. Following a recovery in output, Iran's crude oil barrels are now flowing freely to China, Europe, India, Japan, and Korea. With US Congress now on notice and President Trump having made his position very clear, the risk of an escalation in US-Iran tensions has grown.
However, a more balanced market is not necessarily a godsend for all producers. It is crucial to understand that even if spot prices have risen meaningfully, forward prices in 2020 for both Brent and WTI have remained rather low. On the one hand, the rapid rotation from contango into backwardation in the Brent crude oil market has effectively helped increase Opec revenues.
On the other, falling forward prices have reduced the margin that US shale producers can achieve for fully hedged production. In short, Opec has achieved its goal of pushing the global oil market into backwardation, a shift that will likely discourage new investment.
Inventory draw points to a global deficit
“As the oil market shifts into deficit and Opec forces global crude oil markets into backwardation through deep supply cuts, we project OECD total oil inventories to decrease meaningfully over the next few months to 2.9 billion barrels,” BofAML said.
The decline in stocks is already very visible at the petroleum product level and even at the international crude oil market level. However, bloated crude oil inventories in North America likely will remain the Achilles heel of the oil market, negatively impacting WTI. Specifically, the WTI crude oil market remains in contango and will likely remain so for the time being.
World oil consumption likely will expand fast again in 2018
The success of Opec's efforts to rebalance the global crude oil market depends heavily on continued oil consumption growth. On our estimates, global oil demand will grow by 1.5 million b/d in 2017 and 1.5 million b/d in 2018, providing support to oil prices in the months ahead. However, we believe that supply and demand will remain finely tuned, with quarterly surpluses and deficits likely staying below 0.5 million b/d for the next five quarters.
According to BofAML, improving cyclical conditions and a recovery in economic growth will support oil consumption in 2018, and we believe there is enough flexibility on the supply side to keep prices steady.
Extension of the Opec deal through 2018
Arguably, some of the uplift in global Brent crude oil prices has come on the back of Saudi export cuts this summer. As Saudi Arabia has turned more serious about addressing high inventory levels, Opec compliance with the December 2016 deal has started to exceed market expectations.
According to BofAML, the Saudi position directly reflects the cartel's dilemma: deeper cuts push up prices, and in turn higher prices lead to higher US shale oil production. “With shale output looking set to grow in 2018E faster than we expected in June, we now project limited Opec supply growth in 2018, and we implicitly expect the deal to be extended in some form until the end of 2018,”it said.
Electric vehicles concerns will discourage investment
But the key point is that this lack of investment in refining capacity around the world is not going to be easily resolved. BofAML recently revised up its electric vehicle (EV) estimates to 34 per cent of sales by 2030. Of course, the uncertainties created by the rapid introduction of EVs into the global car fleet are an existential problem for the refining industry.
Should EV sales get to our analysts' projected level on the projected timeframe, oil demand growth could collapse as soon as 2022/23E. Why invest billions of dollars in refining capacity that will come on stream in 2022 just as EVs hit the road? Instead, many refiners may opt to minimize short-term investment, maximize short-term profitability, and run refineries as terminal value assets, according to BofAML.