By Navneet Damani
Crude oil traded at the lowest since June 6 and lost about 1 per cent last week due to combination of bullish and bearish news that drove markets for much of the week.
The news of the US asking OPEC to increase oil output by 1mb/d (million barrel per day) in the second half of 2018 and rising US oil production has put downward pressure on prices. Meanwhile, prices slumped after China threatened duties on American crude imports in an escalating trade dispute with Washington.
Conversely, prices were supported by collapsing production from Venezuela and anticipated resistance from other OPEC members to increase production at the June 22 meeting in Vienna in Austria.
Oil prices have fallen due to the direct result of the market recalibrating to the likelihood of higher OPEC plus production in the second half of the year. Indeed, the single largest factor that could push prices down going forward would be a sizable increase in OPEC plus supply.
However, OPEC and Russia are not the only factors at play. A few other factors could help keep a lid on oil prices over the next year or so. The first thing that comes to mind is soaring US shale supply. The US has added somewhere around 8,00,000 bpd since the start of the year, a staggering sum. Infrastructure constraints in the Permian are real, but so far they have not slowed output.
The IEA monthly report stated that oil market is finely balanced and vulnerable to disruption and said OPEC swing producers and others might need to raise their production, even as it noted some factors on the demand side are likely to have a moderating influence. The IEA predicted that Venezuela's oil output could fall to just 8,00,000 b/d or even lower next year, from 1.36 million b/d in May and following a 1 million b/d fall over the last two years.
It estimated OPEC production had risen by 50,000 b/d in May to 31.69 million b/d. Meanwhile, Middle East OPEC producers and Russia can quickly boost crude production by around 1.5 million b/d to make up for Venezuela's increasing output loss as well as the potential decline in Iranian oil output when US sanctions are implemented.
The bottom line is IEA expects oil demand to grow by 1.4 mb/d this year, but non-OPEC supply will grow by 2 mb/d. Next year, the story is the same i.e. demand grows by another 1.4 mb/d, and non-OPEC supply will grow by 1.7 mb/d. These numbers suggest that US and handful of other non-OPEC countries will more than meet global demand.
Meanwhile, in the monthly report by OPEC, the oil grouping revised up its non-OPEC supply growth estimate by 1,30,000 bpd compared with last months report, and now expects non-OPEC supply growth of 1.86 million bpd in 2018 against 2017.
World oil demand in 2018 is forecast to grow by 1.65 mb/d, broadly unchanged from previous months assessment, to stand at 98.85 mb/d. OPEC oil production increased by 35,000 barrels a day in May month on month to average 31.87 million barrels a day. Output in Saudi Arabia jumped by 85,500 barrels a day, but was partly offset by production outages in Nigeria, Venezuela and Libya. Saudi Arabias own data for May showed it increased its own output by 161,400 barrels a day.
The US Federal Reserve has hiked interest rates, which is putting pressure on indebted countries, making debt harder to pay off, particularly as their currencies weaken relative to the dollar. This is by no means a foregone conclusion, but an economic downturn could cut into demand.
Meanwhile, Russia plans to propose the OPEC/non-OPEC allies next week that they reverse the groups production to the October 2016 levels — the baseline for the cuts of most pact participants when they had pumped as much oil as they could to blunt the cuts impact later is putting pressure on crude oil prices.
Meanwhile, US drillers added one oil rig last week, bringing the total count to 863, the highest number since March 2015 reported. That modest rise marked a fourth straight weekly climb, likely signalling further gains in US output levels. Domestic oil production is currently at an all-time high of 10.9 million bpd.
On the positive side, there are various factors that are supporting crude oil prices. Global inventories are back to their five-year average. But the outlook for higher oil prices comes down to the severe production outages in several places, with Venezuela front and centre.
In the meantime, the storage capacity at Ras Lanuf port had been cut by 4,00,000 barrels after a second crude oil tank was set on fire amid fighting between rival factions for control of two key export terminals in Libya.
Elsewhere, Venezuela, which faces the threat of US sanctions and is in the midst of an economic crisis, is nearly a month behind delivering crude to customers from its main oil export terminals, and chronic delays and production declines could breach state-run PDVSA's supply contracts if backlogs are not cleared soon.
Tankers waiting to load more than 24 million barrels of crude, almost as much as state producer PDVSA shipped in April, are sitting off the Opec member's main oil port.
In an escalating spat over the American trade deficit with most of its major trading partners, including China, US President Donald Trump last week pushed ahead with hefty tariffs on $50 billion of Chinese imports, starting on July 6.
China on Friday said it would retaliate by slapping duties on American export products, including crude oil. The potential drop-off in American oil exports to China would benefit other producers, especially from OPEC and Russia as China may just replace some of the American oil with Iranian crude.
China's aggressive riposte to Trump took some in the industry by surprise. US crude exports to China have been rising sharply, thanks to production surge in the past three years that was a welcome alternative to make up for the cut in supplies from OPEC and Russia.
For Opec, the next move will be to consider to return to a compliance ratio of 100 per cent of the agreed production cuts of 1.8 million barrels per day in 2016. The compliance with agreed cuts has reached 172 per cent and any reduction will translate into drop of 3.1 mb/d.
OPEC crude production in May slid for the fourth straight month to 31.90 million b/d, the lowest in over a year. Outages due to the troubles in Nigeria and Venezuela's oil industries more than offset higher output from Saudi Arabia, Iraq and Algeria as May production fell 1,00,000 b/d from the previous month. OPEC output was last lower in April 2017 at 31.85 million b/d, the last month before West African producer Equatorial Guinea became its newest member.
To sum it up, markets will be waiting for meeting between OPEC and non-OPEC producers which are touted as key to outlook for crude oil prices and will meet in June to assess market conditions and discuss a tapering of production curtailments in order to maintain market balance now that global oil inventories have declined to the five-year average.
There are expectations for the oil cartel to consider altering a production deal that has held back 1.8 million bpd from the market for the past 18 months. We expect prices to be in broad range of $63 and $66 on the WTI, with heightened volatility ahead of the event.
(Navneet Damani is AVP Research at Motilal Oswal Commodities)