The Following Turning Point blog is provided by Brian Milne, Editor and Product Manager at DTN, a leading source of analysis serving commodity oriented industries.
Now in its third year, there is increasing evidence an oversupplied global oil market is clearing excess inventory and moving into better balance with demand. A major contributor to this is the more than eight months of production restraint from the Organization of Petroleum Exporting Countries (OPEC) and their non-OPEC partners, which has led to a halving of the surplus held by countries with the Organization for Economic Cooperation and Development (OECD). A particularly striking statement from last Friday’s Joint OPEC/Non-OPEC Ministerial Monitoring Committee (JMMC) meeting in Vienna declared compliance with their production agreement reaching 116% in August. For an organization that has a history of less than stellar compliance with production agreements, this declaration by JMMC is significant. So is the importance for the economies of OPEC producers that oil prices move higher, with the 14 member countries heavily dependent upon revenue from oil export sales to fund their governments.
In its most recent history, previous attempts by OPEC to push up oil prices proved transitory, with a skeptical market uncovering some disappointment with agreements or execution. So, as OPEC keeps a close watch on the price of oil, with the market’s eyes wide open all the time, can OPEC continue to “Walk the Line?”
There are three key dynamics driving the price of oil in the current market–the rate of U.S. oil production, OPEC-Non-OPEC compliance with their roughly 1.8 million bpd in production cuts, and global oil demand growth. In September, all three components moved favorably toward rebalancing.
The Energy Information Administration (EIA) lowered its projection for U.S. oil production from August, cutting by 1% expected output for 2017 to 9.25 million bpd and by 0.7% for 2018 to 9.84 million bpd in its September Short-term Energy Outlook. Outspoken Harold Hamm, chairman of Continental Resources (Continental), still thinks that’s too high, recently telling Bloomberg News that the nearly 1.0 million bpd annual increase from December 2016 to the end of 2017 is “just flat wrong.” Hamm said the projection doesn’t account for the industry’s new discipline in securing a return on investment.
Data from Baker Hughes, Inc. speaks to that point, with the oil services company showing a 12-rig decline in active U.S. oil rigs so far in the third quarter which compares with a 94 rig increase for the second quarter and a 137 rig gain in the first quarter.
World oil demand growth expectations for this year and 2018 were revised higher in September by EIA, OPEC and the International Energy Agency (IEA), with IEA in their Oil Market Report indicating global oil demand during the second quarter surged 2.3 million bpd or 2.4% compared with the comparable quarter in 2016, which was the greatest quarterly year-on-year increase since mid-2015. Demand from the OECD countries “continues to be stronger than expected, particularly in Europe and the US,” said IEA.
IEA also noted that forced refinery outages in Texas due to Hurricane Harvey, namely the deluge of flooding even as the storm lost intensity, prompted steep drawdowns in oil products that would help work down the surplus in commercial stocks stored by the 35 countries that make up the OECD. Indeed, for the first week of September, EIA reported the largest single week drawdown from U.S. gasoline inventory at 8.428 million bpd in its records, which date back to 1990.
The sudden tightness in U.S. gasoline supply pressed forward cover down to 22.7 days through mid-September, a two-year low. Investment bank Goldman Sachs said reconstruction activity could lift demand for fuels in the coming months. Crack spreads have surged.
Operators at several refineries are postponing their autumn maintenance programs, which promise greater demand for crude oil during the usual seasonal shoulder period, while IEA forecasts crude inputs at global refineries to reach a record level of 80.9 million bpd in the fourth quarter.
“Depending on the pace of recovery for the US refining industry post-Harvey, very soon OECD product stocks could fall to, or even below, the five-year level,” said IEA.
Along with market stability, OPEC said the goal of coordinated production cuts is to erase the surplus in OECD commercial oil stockpiles. In their news release September 22, JMMC said 168 million bbl of the surplus was drawn down during the first eight months of 2017. “[H]owever, there remains another 170 million barrels of stock overhang to be depleted,” said JMMC.
Brent futures traded on the Intercontinental Exchange moved into backwardation in September, a bullish market structure in which futures contracts closest to delivery trade at a premium to deferred delivery. The forward curve is telling industry demand for barrels of Brent crude oil sold now are worth more than barrels stored for delivery in later months despite the storage costs.
Brent was last in an enduring backwardated market structure from early 2011 through mid-2014, with the futures contract nearest to delivery holding above $100 bbl for most of the period. Brent’s oil price subsequently crashed from a $115.71 bbl high in June 2014 to a $27.10 bbl low in January 2016.
OPEC and non-OPEC production cuts muscled up the value of Brent crude, the international price marker for oil, while supply in floating storage continues to decline. Brent futures also widened its premium to West Texas Intermediate futures traded on the New York Mercantile Exchange, the U.S. oil price marker, to a nearly 2-1/2 year high over $6 bbl.
For the first time since May, NYMEX WTI futures ushered in autumn by settling above the psychological $50 bbl barrier for more than a single session. The Commodity Futures Trading Commission’s weekly Commitment of Traders report shows open interest soared to a record high of 2.4 million during the week which ended September 18, indicating a strong appeal in owning the futures contract. Noncommercial traders, also speculators since they are not using the futures contract to hedge an underlying position in the physical market, moved to a one-month high net-long position, with a long position taken on expectation that prices would move higher over time. Since noncommercial traders are not using a futures contract to hedge a physical position and can move in and out of trades quickly, they offer a good guide to market sentiment.
The strong interest in NYMEX WTI futures, partly due to short covering by market participants expecting a lower oil price, also comes with increased hedging activity by shale oil producers. Boston-based ESAI Energy said producers will seek to increase their hedges for 2018.
“Even with a slowdown in rig count, shale production, led by the Permian Basin, will rise roughly 450,000 b/d to average 5.6 million b/d in 2018. Hedging will increase and support further growth if the forward curve for WTI moves over $50,” said the consultants.
Criterion Research LLC said on September 12, crude oil hedged by commercial interests reached 1.24 billion bbl, just off the record high of 1.26 billion bbl on February 14.
“The main difference between then and now is that NYMEX WTI Crude Oil prices were trading at $53.20/Bbl vs. $48.23/Bbl,” said the Houston-based company in their most recent Crude Oil Production Outlook, saying they believe this “highlights the perceived downside price risk to the producers.”
After lightening positions through much of the second quarter, Criterion said producers have added hedges on every price rally since June 23, when NYMEX WTI futures settled at $43.01 bbl.
“With the benefits of lower production costs and operating expenses, we believe producers will continue to add additional positions to protect operating cash-flows,” said Criterion.
The Houston researchers also point to increased takeaway capacity for producers that have lowered their operating costs, highlighting several pipeline expansions and new construction that’s underway, with another nine projects announced. These projects, along with the May completion of the Dakota Access Pipeline and Energy Transfer Crude Oil Pipeline Project, provide 3.76 million bpd of additional capacity in moving crude oil from oil fields in Oklahoma, the Bakken Formation, and Permian Basin.
“As a result of the Dakota Access Pipeline (DAPL) going online in mid-2017, pipeline takeaway capacity was able to surpass crude oil supply in the Bakken for the first time in the past 5-years,” said Criterion. “The completion of the DAPL has also resulted in declining differentials in the region, with Continental citing that they expect a $2.00 improvement in the second half of 2017. Similarly, Samson Oil & Gas reported that their oil price differential fell from $6.50/bbl to $3.58/bbl due to the Dakota Access Pipeline.”
The combination of lower costs and increased hedging, not to mention a still high U.S. oil rig count of 744 as of September 22, strongly suggests U.S. oil production will continue to grow, albeit at a slower pace than what was seen in the first half of 2017.
That brings us back to OPEC, who will meet in Vienna on November 30 to discuss the success with their production agreement in concert with 10 non-OPEC oil producers, including Russia, which currently runs through the end of the first quarter 2018.
There have already been several media reports on discussions between key members of the OPEC-Non-OPEC pact, including Saudi Arabia and Russia, on whether the agreement should be extended until June 30, 2018, or through the end of the 2018. Speculation also includes deepening the production cuts by 1%.
There’s also the matter of two OPEC members that were exempt from the production agreement, Libya and Nigeria, because of internal struggles with militants. Both countries have struck agreements with militants, and have ramped up production sharply, diminishing the effect of the voluntary OPEC-Non-OPEC production cuts. OPEC is expected to bring these two countries into the agreement.
Traders are closely watching these developments and failure to enhance their agreement or if compliance falters, will “as sure as night is dark and day is light,” trigger a selloff and again press NYMEX WTI futures below $50 bbl. So, as OPEC tries “to turn the tide,” will its members continue to “walk the line.”
Released in 1957, “I Walk The Line” was Johnny Cash’s first number one hit, and is included in “The 500 Songs That Shaped Rock and Roll,” which is on permanent exhibit at the Rock and Roll Hall of Fame.
We would like to thank Brian for today’s blog and we certainly value his experienced and studied views on oil markets. We constantly update our own independent views on crude and product prices to reflect market developments such as OPEC actions. These analyses are used to assist all segments of the oil industry in responding to these and other developments and are included in a variety of our subscription products. We also employ our market analysis to assist industry participants on specific and focused consulting engagements. Please contact us through our website, by calling 214-754-0898, or by emailing me directly at email@example.com if we can be of assistance or answer any questions.
About the Author
Brian L. Milne is the energy editor and a product manager with DTN. Milne manages the refined fuel’s editorial content, spot price discovery activity, and cash market analysis for DTN’s energy segment. Milne and his team communicate with suppliers, brokers and fuel buyers in the bulk wholesale market in refined fuels throughout each business day.
Milne has more than 20 years of experience in the energy industry as an analyst, journalist, and editor, serving as managing editor for Btu publications and journalist with Bridge Information Systems America before joining DTN in 1999. His industry and market focus include natural gas, NGLs, and electricity during its move to deregulated markets in the late 1990s, biofuels, and the downstream petroleum industry. Milne graduated Magna Cum Laude from Monmouth University in New Jersey with a Bachelor of Arts in history and an interdisciplinary in political science.
DTN is the independent, trusted source of actionable insights for 600,000 customers focused on feeding, protecting, and fueling the world. Customer-centric and employee-driven, the company focuses on empowering agriculture, oil & gas, trading, and weather-sensitive industries through continuous, leading-edge innovation. Based in Minneapolis and Omaha, Nebraska, DTN is owned by TBG, a private century-old investment holding company headquartered in Zurich.