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Can OPEC Supply The Tighter Oil Market It Predicts?

Onshore Drilling Rig

OPEC expects oil demand to remain strong through 2017, but downgraded its assessment because of the Brexit result.

In its latest monthly Oil Market Report for July, OPEC sees oil demand rising this year and next, almost exclusively from non-OECD Asia. The OECD, which includes the U.S. and Europe, only posts a weak 0.10 million-barrel-per-day (mb/d) increase in demand next year under OPEC’s forecast. The other 1.1 mb/d comes from the non-OECD, mostly from Asia.

Growing demand will help the oil market continue to move towards a balance, OPEC argues, while at the same time oil supply also steadily falls. Non-OPEC supply contracts through next year with output falling by an additional 0.11 mb/d in 2017, which comes on top of the 0.9 mb/d decline from non-OPEC countries this year. U.S. shale has borne the brunt of this adjustment – U.S. oil production could be down by as much as 1.2 mb/d so far since peaking in April 2015. The latest data from the EIA shows oil production down 194,000 barrels per day for the week ending on July 1, a sharp drop off that puts overall U.S. output at just 8.4 mb/d. Falling production from the U.S. and elsewhere comes at a time when OPEC is keeping output steady, which has allowed the cartel to capture its largest market share since 1975.

That also means that demand for OPEC oil will continue to rise as it replaces lost output elsewhere. OPEC believes that the market will demand 33 mb/d from the group in 2017, up 1.1 mb/d from this year. That is also 142,000 barrels per day more than OPEC actually produced last month. If OPEC is unable to boost production – which could be a difficult task given some declines expected in places like Iraq and Venezuela, as well as supply disruptions in Nigeria and Libya – inventories will be drawn down. That will help support prices. Related: Shell’s New Sensors Could Reduce Exploration Costs Dramatically

Of course, global inventories matter just as much, and with falling production in the shale patch, storage levels should continue to come down in the U.S. as well. “Market conditions will help remove overall excess oil stocks in 2017,” OPEC wrote in its report.

While OPEC voiced some semblance of confidence in the trajectory of the oil market, it cautioned that the Brexit will dampen global growth, which will cut into oil demand. OPEC downgraded its global GDP growth estimate to 3 percent from 3.1 percent. Softer growth will occur in the UK and Europe especially. The Brexit also presents new variables that are difficult to predict, namely, how will central banks respond? There is a consensus that central bank policies will “remain accommodative,” particularly after the Brexit vote when the British pound began plunging. Looser monetary policy from Europe, the UK, or Japan will put pressure on the U.S. Fed to hold off on an interest rate hike. The Fed will take another look at the end of this month, but most analysts see an interest rate increase as unlikely. Related: Citibank: We’re Nearing A Bull Market For Oil

At the same time, the swift hand off in power in the UK to a new Prime Minister was welcomed by the markets. The pound rebounded and the dollar slid, helping to push up oil prices. WTI and Brent moved up by more than 4 percent during midday trading.

Then again, a Reuters report hinted that the sharp increase in oil prices could have been technical in nature, meaning speculators drove up prices after concluding that they fell too far. In recent weeks, hedge funds and other money managers had sold off long positions on crude, and shorts increased. Some see Tuesday’s rally as a correction. “The sharper move up caught everyone by surprise as there's probably short covering adding on to the technical buyback," an unnamed crude futures broker told Reuters.

The longer-term is a bit clearer. As OPEC lays out, the logic is pretty straightforward: demand continues to rise and supply continues to fall. 2017 is shaping up to be much tighter.

By Nick Cunningham of Oilprice.com

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