Its hard to believe there is bad news for OPEC with Brent trading this morning at $69.60 (830am MST), but there is bad news or at least a wake call for OPEC with the EIA increasing its US oil production growth forecast to 0.97 mmb/d YoY in 2018, up from its Dec forecast of 0.78 mmb/d YoY growth in 2018. And this wake up call will be even louder next month as the EIA will likely increase its 2018 US oil growth again as the Jan 2018 forecast is based on WTI $55.33/b. The last thing OPEC wants is to see greater than expected oil supply growth, especially in Q4/18 when the OPEC cuts are scheduled to end. Its why we expect to see OPEC increasingly talk down oil markets by reminding that the cuts continue to show rebalancing is on track, but that rebalancing is still later in 2018. OPEC’s challenge has switched from getting Brent to $60 to trying to make sure high oil prices don’t lead to oil supply surprising to the upside just as OPEC wants to end it cuts. This is especially so if the cuts end at Dec 31, 2018 as oil demand is always seasonally lower in Q1 than in the summer seasons. Look for more OPEC comments like this morning’s comments from the UAE oil minister that oil rebalancing is not there yet.
Expect OPEC to increasingly remind that rebalancing isn’t there yet, it will take most of 2018. There was a wake up call for OPEC with the new EIA forecast for US oil production growth. The EIA now forecasts US oil production to increase by 0.97 mmb/d YoY in 2018 whereas a month ago it was a much lower 0.78 mmb/d YoY growth in 2018. This should lead to an increased messaging from OPEC that rebalancing of oil markets is not there yet. While the OPEC/non-OPEC group continues to show strong overall compliance, rebalancing won’t be there until much later in 2018. We saw a good example of this messaging this morning with the CNBC story “2018 will be the year oil markets become balanced, UAE oil minister says” [LINK] . The UAE minister reminds that rebalancing still isn’t there yet. CNBC wrote “Speaking to CNBC at the 9th Gulf Intelligence UAE Energy Forum in Abu Dhabi, Suhail al-Mazrouei said progress was being made, but there’s more that must be done. “The market fundamentals in 2017 have been good but we’re looking forward to seeing another healthy year of production in 2018,” he said. “The concern is to achieve that balance between supply and demand, and we’re not there yet.” But al-Mazrouei believes this year could see the oil markets finally achieve an equilibrium. “I am expecting that we will still see corrections in 2018 and I think it’s the year of … the market fully achieving the balance,” he said.”
OPEC doesn’t want to see high oil prices lead to greater oil supply by year end 2018 ie. when its planned cuts end. OPEC’s cuts are planned to end at Dec 31, 2018, and the last thing OPEC wants is for a rush of oil supply to come onstream by year end 2018. Especially since global oil demand is always seasonally lower in Q1 of every year. We posted our Dec 5 blog “The Only Logical Time For OPEC To Start To Unwind The Cuts Is In July To Avoid Recreating A Surplus Problem” [LINK] because of the supply/demand challenges for OPEC if it ends its cuts on Dec 31, 2018. The fact that demand is always seasonally lower in Q1 of each year is why it seems to us to be the wrong time for the ~1.8 million b/d of potential cut volumes to come back on the market. Our Jan 9 blog “Good News For OPEC, International Rigs Not Yet Responding To Brent’s Recent Move To High $60s” [LINK] noted that drilling rigs outside of the US haven’t really responded to high oil prices and are not yet pointing to any stronger than expected increase in global oil production the US. But the EIA’s increase to US oil production forecast using oil price assumptions well below the strip has to bring concern to OPEC that US oil production growth is going even higher in H2/18.
The EIA’s Jan STEO forecasts US oil production to be up 0.97 mmb/d YoY in 2018. The EIA released its monthly Short Term Energy Outlook Jan 2018 this week. We plan to write on natural gas takeaways from the STEO in our upcoming Energy Tidbits Jan 14, 2018 memo, but, for oil, the big negative is the EIA increasing its forecast for US oil production growth in 2018 from its Dec forecast. The EIA increased its 2018 forecast by 0.25 mmb/d from its Dec forecast. The new forecast is for US oil supply to grow by 0.97 mmb/d YoY in 2018 to 10.27 mmb/d, and then grow a further 0.58 mmb/d in 2019 YoY to 10.85 mmb/d. Note the EIA’s Dec forecast had 2018 growth YoY of 0.78 mmb/d, but had a lower 2017 base of 9.24 mmb/d vs the new 2017 base of 9.30 mmb/d. Below is our ongoing table showing the EIA’s forecast by forecast month
EIA Estimated US Crude Oil Production By Forecast Month
The EIA Feb forecast will inevitably be even higher – it used WTI $55.33/b for this forecast. We don’t know specifically how the EIA develops its oil supply forecast growth, but the formula can’t be different than what we used in our 15 years of sellside research on oil and gas E&P companies – the level of growth starts with the level of capex and the level of capex depends first upon cash flow and then other capital (ie. equity). Higher oil price assumptions means higher cash flow (adjusted for any increases in cost structure) and higher cash flow is higher capex and more wells drilled. The EIA’s STEO Forecast Highlights states “Brent crude oil prices averaged $54/b in 2017 and are forecast to average $60/b in 2018 and $61/b in 2019. West Texas Intermediate (WTI) crude oil spot prices are forecast to average $4/b less than Brent prices in both 2018 and 2019.” The STEO detail (Table 1) shows the precise assumption is WTI $55.33 in 2018 and WTI $57.43 in 2019. We expect that a Feb 6 STEO report release means that they run their forecast as of Jan 31. Oil prices would have to dramatically change over the balance of Jan for the EIA to not have to increase their oil price assumptions for their Feb STEO. As of last night, the WTI strip for 2018 was >$62/b.
Plus there has to be the additional fear that equity comes back to US oil companies. The messaging from the US E&P companies has shifted to a value over volume focus. We believe this is due to the fact that equity wasn’t there for US E&P companies in 2017 and its mostly a forced focus on value over volume. As noted in the table below, equity issues for the US E&P group was down dramatically in 2017 vs 2016. Maybe some of the large E&P companies are fundamentally and forever changing to returns focus. But we don’t expect that is the majority and that a return of equity would bring them back to a volume focus.
US E&P Equity Issues (US$ billions)
Source: Bloomberg, Stream Asset Financial
Next week’s IEA OMR will likely continue to question if oil rebalances in 2018. OPEC should get help in talking down the market when the IEA is scheduled to release its monthly Oil Market Report on Jan 19. We expect they will likely keep a similar messaging as they did in their Dec OMR that it the rebalancing is a tight proposition. Last month, the IEA wrote “So, on our current outlook 2018 may not necessarily be a happy New Year for those who would like to see a tighter market. Total supply growth could exceed demand growth: indeed, in the first half the surplus could be 200 kb/d before reverting to a deficit of about 200 kb/d in the second half, leaving 2018 as a whole showing a closely balanced market. A lot could change in the next few months but it looks as if the producers’ hopes for a happy New Year with de-stocking continuing into 2018 at the same 500 kb/d pace we have seen in 2017 may not be fulfilled.” One reminder on the IEA is that they tend to be conservative in their demand forecasts. Our Nov 15, 2017 blog “Timely To Remember IEA’s Nov Oil Demand Forecasts Almost Always Turn Out To Be Lower Than Actuals” [LINK] highlighted how the IEA has tended, on average, to be ~0.4 mmb/d low on its early forward year demand forecasts.
One overlooked tight oil market factor is the dwindling OPEC surplus capacity. As long as the global oil inventories are above 5 year averages (ie considered high), an overlooked factor supporting tighter oil prices going forward is the declining OPEC’s surplus crude oil capacity. The EIA’s new STEO says “OPEC surplus crude oil production capacity, which averaged 2.1 million b/d in 2017, is expected to fall to 1.8 million b/d in 2018 and to 1.3 million b/d in 2019. Surplus capacity is typically an indicator of market conditions, and surplus capacity lower than 2.5 million b/d indicates a relatively tight oil market. However, ample global oil inventories make the forecast of low surplus capacity less significant”. A declining OPEC surplus capacity will give support for the oil prices >$60 for longer.
EIA STEO: OPEC Surplus Crude Oil Production Capacity (million b/d)
The EIA’s wake up call will be even louder next month so look for more OPEC reminders that rebalancing isn’t there yet. It is important to remember that the EIA used WTI $55.33/b for its Jan STEO, which means that its Feb forecast is inevitably going higher. This is a wake up call for OPEC. Its may have been manageable for US oil supply to increase by 0.78 mmb/d YoY in 2018 and the new forecast growth of 0.97 mmb/d growth may be borderline except for the fact that OPEC must see that the EIA’s forecast is going higher next month given the WTI $55.33/b assumption. We expect OPEC to try to talk down the market if anything just to avoid a return of equity to the US E&P companies to make the oil supply problem even worse.