OPEC said that the global oil supply surplus has nearly been eliminated, although the group is shifting its sights on lack of investment in upstream supply.
In OPEC’s May Oil Market Report, the group noted that non-OPEC supply continues to grow at a rapid rate, adding 0.87 million barrels per day (mb/d) in 2017, with expectations of another 1.7 mb/d in 2018, 89 percent of which will come from the U.S. In fact, non-OPEC supply is expected to outpace demand growth, even though demand will expand by a robust 1.65 mb/d this year.
But OPEC also warned that “non-OPEC capital expenditure (CAPEX), including exploration, increased by only 2% y-o-y. Moreover, it has seen a decline of around 42% compared to the 2014 level.” While that seems like a bit of a throw-away line given the enormous production increases from U.S. shale, the focus on upstream investment has been a growing point of emphasis for OPEC as it grapples with how to respond to a tightening oil market.
Commercial stocks were only 9 million barrels above the five-year average in March, which is to say, stocks are probably already below the five-year average at this point. That means that OPEC has achieved its goal of shrinking the supply surplus.
That would suggest that the group begins to unwind the production cuts at its upcoming meeting in June, but there has been a reluctance to do so. Saudi Arabia is aiming for higher oil prices ahead of the IPO of Saudi Aramco, expected at some point in 2019.
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Keeping the cuts in place for the remainder of 2018 (OPEC’s initial preference) would seem to require another justification now that inventories are back to the five-year average. Raising alarms about lack of upstream investment could offer such a pretext.
Moreover, OPEC noted that heady projections about U.S. shale growth are not without downside risk. U.S. shale could fail to deliver on aggressive growth figures for several reasons. “The continued strong development of the world economy could lead to rising inflation, and, along with potential trade restrictions, would impact oil production costs,” OPEC said. “In addition, fast-growing US tight oil production is increasingly faced with costly logistical constraints in terms of outtake capacity from land-locked production sites.”
The Permian basin continues to add new supply at a torrid pace, but with pipelines just about filled up, further gains could be harder to come by than the forecasts suggest. Also, investors are increasingly demanding profits returned to them, forcing a new era of capital discipline. Oil companies that have announced spending increases have been punished by Wall Street over the past year, while those that have returned cash to shareholders in the form of share buybacks and dividend hikes have been rewarded. Spending restraint could lead to more modest growth, although that remains to be seen.
Meanwhile, the U.S. decision to scrap the Iran nuclear deal looms over the oil market and OPEC’s deliberations. Any supply outage could force OPEC off of the sidelines, whether they want to act or not. In that sense, the cartel might be compelled to make changes to the deal to allow for more supply in the event of declining shipments from Iran.
OPEC and Russian officials have intimated that they would not let a supply outage rattle the market. “It is too early to say [what the impact of the US decision on the oil market will be]. In any case, we have all the tools that could be used to balance the market,” Russia’s energy minister Alexander Novak said. In OPEC’s monthly report, the group also stated that it “stands ready to support oil market stability, together with non-OPEC oil producing nations” participating in the agreement.
OPEC added a minor 12,000 bpd between April and March, with the loss of 41,000 bpd from Venezuela offset by the 46,500 bpd increase from Saudi Arabia.