The Outlook for Crude Oil in 2017 - “Steady as she goes”
Abu Dhabi 17 January 2017
Last year was one of surprises on both the political and markets side, and the volatility in the crude price reflected some of this. We expect 2017 will be a year of price consolidation initially, replaced later in the year with a slow grind higher. WTI could average between $57-60/barrel
For crude, the defining moment in 2016 was the production cut agreement signed by OPEC members at the end of November, which has helped the market establish a firm base within this latest oil price cycle. Importantly the decision by the organization to reduce its overall production by 1.2 million barrels/ day (MBD) was also combined with an extra 558,000 bpd output reduction from a number of non- OPEC members, meaning a total of 1.758 MBD was removed from the market at the start of 2017.
This deal, which many analysts had thought would never happen, has not only boosted prices but also highlighted the fact that despite the rise of shale, OPEC remains a relevant entity. Considering the above we now estimate that the oil market will return to balance by the 3rd quarter of 2017, and while stocks remain high these excess inventories have already begun to be drawn down, and thus we forecast prices to average $57-60/barrel this year.
Admittedly this slow but steady rise in prices will definitely breathe life back into the fracking industry, and there is the risk that President Trump’s incoming administration will follow through with at least a certain amount of deregulation within the US energy sector, and could even permit the exploration of federal land that until now has been protected from such development by environmental laws.
Potential resurgence of US production
All this will take time, however, as such regulatory changes need to be prepared and then debated, while leaner and meaner shale firms getting ready to re-start their mothballed rigs and explore new fields, if the price holds above $50 a barrel, will also have to wait for their supporting counterparts in the oil services industry to rehire and re-establish their own infrastructure. Thus a potential resurgence of US production, which dipped to 8.7 MBD last year against 9.4 MBD in 2015, may only be felt next year, by which time the global supply glut will likely have disappeared.
On a separate note we also need to consider President Trump’s policy towards Iran, and the chance that he could materially affect the P5+1 nuclear accord (which he has called “the stupidest deal in history”) by either supporting Republican calls for new sanctions on Tehran due to its ongoing missile program, and/or trying to renegotiate the agreement itself. These actions, especially fresh sanctions, could potentially hinder or even reverse last year’s significant recovery in Iran’s oil production.
Venezuela, Libya and Nigeria challenges
Elsewhere, some conventional producers such as Venezuela, Libya and Nigeria continue to face serious domestic challenges outside of just the direction of oil prices. Venezuela, which ironically has the world’s largest reserves of crude, is facing major social upheaval and possible economic collapse due to years of chronic mismanagement and misguided socialist policies initiated by Hugo Chavez and continued by his successor President Nicolas Maduro.
The local currency lost more than 60% of its value last year, and while a higher crude price this year may provide some relief, the country’s overall production and refining capabilities continue to wane due to the state-owned oil company PVDSA’s decaying infrastructure, which is in dire need of repair and upgrading but the company and the government are almost broke. On top of this, a chunk of the oil Venezuela is still able to pump is being re-directed to pay for the billions in loan repayments Caracas owes to China in lieu of cash.
On the other side of the Atlantic, Nigeria whose oil-related infrastructure also requires significant upgrading, is battling to end separatist activity within its strategically important Niger Delta region where militants have in the past year increased their attacks on pipelines and foreign owned oil facilities disrupting production and exports. Meanwhile in Libya despite a 100% increase in its crude production to almost 600,000 BD late last year, this is still far below its pre-revolution level of 1.6 MBD, while output continues to ebb and flow due to power shortages and ongoing civil conflict which has prevented the establishment of a central government recognized by all political forces within the country.
Decline in capital expenditure
On the technical front, a subject which we have raised in a number of our regular market commentaries since January last year is the ongoing decline in capital expenditure by major oil companies. This in our opinion is probably one of the least monitored issues by both the media and some market analysts, but one which we believe could have a significant negative effect on global supplies in the years ahead.
The natural demand growth for crude continues even in the relatively weak economic climate, and according to an IEA forecast late last year, this specific type of growth currently averages 1.2 MBD per annum, while Chevron stated back in 2013 that capital expenditure to maintain current conventional production capabilities and explore new fields just to keep up with this natural demand growth, would need to be in the region of $600 billion per annum.
However over the past two years such expenditure has collapsed due to the lower oil price environment, a situation highlighted in a 2016 Wood Mackenzie report which claimed that CAPEX in both oil and gas has dropped by over $1 trillion since 2014. Meanwhile the number of new conventional field discoveries is at its lowest level since 1947, which is unprecedented.
Expected shortage situation
Now as it takes around 3-5 years from inception to operation for most conventional fields, and bearing in mind most of the world’s main producers have been pumping at close or near to their maximum capacity in order to retain their market share, when the oil market rebalances (an event which as we suggested above could occur by H2 this year) and taking into account the ongoing natural demand, combined with surprise but continued oil purchases by China (7.7 MBD in 2016 against 6.7 MBD in 2015, as its builds it strategic reserves) it won’t take too long for the market to enter a shortage situation, which even with a resurgent shale sector, could open up the risk of a sharper shift higher in prices over the medium term.
Executive Director, Market Insights & Strategy
Extracted from the Global Economic Outlook 2017