The narrative on Tues (WTI down 2.6% to $55.35/b) was all about oil demand growth not being as strong as expected. We thought oil prices overreacted to the IEA lowering its 2018 oil demand forecast by 0.19 mmb/d to 98.9 mmb/d, or an increase of 1.3 mmb/d YoY from 2017. A lower 2018 oil demand forecast is never positive, but, by itself, it shouldn’t have driven oil down very much given the IEA’s track record of being conservative on oil demand forecasts and that its Nov forecasts almost always end up being much lower than actual demand. However, we did expect oil to be down (just not as much) moreso because the market seemed surprised (it shouldn’t have been) by the IEA forecast that oil supply to exceed demand by 0.6 mmb/d in Q1/18. This trend of excess Q1 supply should have been expected by everyone as oil demand is always seasonally lower in Q1 versus the just completed Q4 every year. This week’s market reaction to oil is a good reminder that oil demand is always seasonally lower in Q1 every year and that the IEA’s Nov demand forecasts almost always turn out lower than actual demand. We have to believe that OPEC understands the math of lower Q1 seasonal demand and that is why the OPEC narrative over the past two months has moved to the expectation for the cuts to be extended past March 31, 2018.
The headlines out of IEA’s OMR on Tues morning were all about the IEA’s lowering its oil demand forecast. The headlines and narrative that out were consistent and focused on the IEA lowering its oil demand forecast by 0.19 mmb/d for 2018 for a revised YoY oil demand growth of 1.3 mmb/d in 2018 vs 2017. The WSJ story “Oil-Price Recovery Threatened by Weak Demand, Says IEA” [LINK] opened saying “the crude oil price rally could be short-lived and global oil demand will be weaker than expected this year and next, the International Energy Agency said Tuesday.” The FT story “IEA trims oil demand forecast on higher prices” [LINK] opened “The International Energy Agency on Tuesday lowered its oil demand forecast for this year and next, saying the rally in prices since June was likely to crimp consumption. In its monthly oil market report, the Paris-based agency lowered its 2018 demand growth estimate by almost 200,000 and cautioned that supplies outside Opec were expected to increase rapidly next year, potentially reversing crude’s move above $60 a barrel”.
The IEA’s Nov OMR forecast for the following year oil demand almost always ends up much lower than actual oil demand. The IEA lowering its oil demand forecast is not a positive, but we didn’t share the urgency and panic for the IEA’s lowering its 2018 oil demand forecast as the big negative because the IEA’s Nov forecast for the following year almost always ends up much lower than the actual oil demand. We went back to the IEA’s OMR for the last seven years to prepare the below table that shows how the IEA’s Nov forecast for the coming year turns out. Every year, the IEA normally introduces the next year oil demand forecast in June or July. In this case, the Nov OMR forecast for 2018 demand will be the IEA’s 5th monthly forecast for 2018 oil demand.
For the last 7 years, there has only been 1 year (2012) where the IEA’s early forecast for the out year hasn’t been too low. Looking specifically at the Nov forecast for the out year, the IEA’s Nov forecast was too low by 0.5 mmb/d in 2011, 0.8 mmb/d in 2013, 0.3 mmb/d in 2014, 1.0 mmb/d in 2015, 0.5 mmb/d in 2016, and 0.7 mmb/d in 2017. The only Nov OMR forecast that was too optimistic was in Nov 2012, where it was 0.8 mmb/d too high. The average of all years is >0.4 mmb/d. This is a consistent track record and, if the track record holds, 2018 will end up more like 99.3 mmb/d than the 98.9 mmb/d in the new Nov OMR
IEA Demand Forecast By OMR Forecast Month (million b/d)
Source: IEA Oil Market Report, Stream Asset Financial
The other disappointment (but should not have surprised) is that the IEA forecasts oil supply to exceed demand by 0.6 mmb/d in Q1/18. It didn’t get the same level of attention, but it should not have surprised anyone that the IEA wrote “the oil market faces a difficult challenge in 1Q18 with supply expected to exceed demand by 0.6 mmb/d followed by another, smaller, surplus of 0.2 mmb/d in 2Q18.” This should not have surprised given that global oil demand in Q1 of any year is almost always less than Q4 demand in the just finished year. This is not new, it is the normal seasonal oil demand pattern that happens every year. In the new IEA Nov OMR, the IEA forecasts oil demand to be 97.9 mmb/d in Q1/18, down 0.3 mmb/d from 98.2 mmb/d in Q4/17. This is the key factor leading to the IEA’s view that oil supply will exceed demand by 0.6 mmb/d in Q1/.18. This normal seasonal pattern in oil demand is the key reason why we have been saying that the OPEC cut deal has to be extended past March 31, 2018 to ensure the oil surplus is eliminated. Regardless of whether this should have been expected, the fact it surprised was why we expected oil prices to be weaker on Tues, moreso than the IEA’s 0.19 mmb/d reduction in 2018 oil demand forecast.
Oil markets rebalanced strongly in Q3 as oil demand is always seasonally much higher every year in Q3. One positive from the IEA’s Nov OMR that was mostly overlooked is that there was a bigger correction to the oil surplus in Q3. The IEA said the oil surplus “declined for the fifth straight month to 119 mmb. On the basis of forward demand, commercial stocks covered 62.2 days at the end of September, the lowest level since July 2015”. The data from the previous OMRs shows that the surplus has dropped from 292 mmb in Apr, 266 mmb in May, 219 mmb in June, 190 mmb in July, 170 mmb in Aug and to 119 mmb in Sept. This means it corrected ~61 mmb in Q2/17 and 100 mmb in Q3/17.
This larger correction to oil surplus in Q3 vs Q2 should not have surprised as oil demand is always being up strongly in Q3. This was the focus of our March 29, 2017 blog “Every Year Oil Demand Is Up Big In H2 Vs H1, Expecting +50 Million Barrels Per Month In H2/17” [LINK]. Our blog started “There is a strong logical case for oil hitting $60 before year end if OPEC/non-OPEC extend their ~1.8 million b/d and can manage reasonable (ie. >80%) compliance, even if US oil production continues to grow. Why? EVERY YEAR, oil demand is ALWAYS up strongly in H2 vs H1. Every year, oil demand follows a seasonal pattern. The low demand period every year is Q1. Then oil demand starts to pick up slightly in Q2, but the big increases in oil demand are every year in Q3 and Q4. Oil demand in H2 is expected +~1.7 million b/d, or ~50 million barrels per month of increased oil demand vs H1/17.” Our March 29 blog concluded” As inventories track down with the always increasing oil demand each summer, this should be the setup that can lead to oil getting back to $60 by year-end 2017. Oil hitting $60 in late 2017 is likely not to be lasting too long as $60 oil will be a temptation for OPEC members and Russia to tweak up production. But with Saudi Aramco’s planned 2018 IPO, we can see oil hanging in the $55 range. All in all, the always higher summer demand for oil should provide for higher oil prices and a change in tone from negative to positive on oil.”
IEA’s lower 2018 oil demand forecast should not, by itself, have sent oil prices down by much on Tues. The IEA lowering its oil demand forecast is not positive, but the market’s reaction thereto makes it timely to remind that the IEA’s Nov forecasts for the subsequent year almost always turns out to be low compared to actual oil demand. For this reason, we didn’t think that the lower forecast, by itself, should have led to oil prices down 2.6% to $55.35/b. However, we did expect oil to be down (just not as much) moreso because the IEA forecast that oil supply will exceed demand by 0.6 mmb/d in Q1/18 seemed to surprise. This is a reminder that oil demand is always lower in Q1 every year. We have to believe that OPEC understand the math of lower Q1 seasonal demand and that is why the OPEC narrative over the past two months has moved to the expectation for the cuts to be extended past March 31, 2018.