The global glut in oil supplies could shrink substantially in the second half of this year, signaling a potential rise in oil prices in just a few months.
The latest monthly Oil Market Report from the International Energy Agency concludes that the supply overhang currently stands at about 1.5 million barrels per day (mb/d), which should persist through the 2nd quarter.
However, that excess vanishes almost entirely in the second half of the year. The IEA sees the oversupply situation narrowing to just 200,000 barrels per day on average in the third and fourth quarter.
Just a few days earlier, the U.S. Energy Information Administration issued a much gloomier assessment, predicting that supply outstrips demand by 1.4 mb/d on average for the entire year, before contracting to 400,000 barrels per day in 2017. Under the EIA’s scenario, oil prices could remain relatively low for another year or so – the agency predicts prices to average $34.60 per barrel this year and only $40.58 per barrel in 2017.
But the Paris-based IEA says that the current futures market better reflects its prediction of a more rapid balancing. The contango situation that has characterized the futures market has recently narrowed and even disappeared. Contango is a situation in which oil contracts for prompt delivery are traded at a discount to oil delivered in the future. A contango tends to reflect a near-term glut in supply – one way of looking at it is that suppliers need to discount their oil today in order to find enough customers, while there is less pressure to discount for future deliveries because the markets expect the glut to ease.
However, the contango flipped to “backwardation” in early April – the reverse of contango – which is when front-month deliveries are traded at a premium to future contracts. The IEA says this is “partly on the back of summer maintenance plans in the North Sea, but also due to the general feeling of impending market tightness.”
Backwardation can also reflect less-informative temporary factors, such as a short-covering rally or near-term supply outages, such as in Iraq and Nigeria. However, as John Kemp of Reuters noted on April 14, the contango is shrinking even on contracts much further out, where these idiosyncratic factors should have less of an effect. For example, the discount for oil delivered in the fourth quarter of 2016 compared to an average of oil deliveries for 2017 has narrowed from $3.75 per barrel in December to $2.50 in February. It shrank even further to $1.65 by mid-April. In other words, the futures market is reflecting a growing confidence that the oil glut is waning.
This confidence stems from the changes in the physical market for crude oil. Global oil supplies fell by 300,000 barrels per day between February and March, led by an 180,000 barrel-per-day decline from non-OPEC countries. The IEA said “[e]vidence that spending cuts are starting to impact on U.S. production mount,” while “[m]aintenance and unscheduled outages curbed supplies in Canada and Ghana.” Related: U.S. Oil Supply To Fall Faster Than Expected
OPEC also saw production dip in March, falling by 90,000 barrels per day. Supply outages in Nigeria, Iraq, and the UAE more than offset the gains from Iran. Iran has brought 400,000 barrels per day back to the market since the start of 2016, which is “more measured than some expected,” according to the IEA. Related: U.S. Oil Industry Fears That New Regulation Could Cost $25B
Looking forward, global supplies will continue to fall. The IEA dismissed the OPEC-Russia summit in Doha this weekend as a sideshow, saying that “if there is to be a production freeze, rather than a cut, the impact on physical oil supplies will be limited.”
Regardless of the meeting’s result, the trend is clear. Non-OPEC supply – led by the declines in U.S. shale – was down 690,000 barrels per day in March compared to the same month in 2015. The U.S. rig count is down more than 80 percent, and the EIA expects output to average just 8.6 mb/d in 2016, which will require a sharper contraction from the 9 mb/d produced in March. Production could fall to just 8.0 mb/d in 2017. And there are very few non-OPEC countries that would even have the ability to ramp up production this year.
In summary, the significant declines in oil supply combined with the 1.2 mb/d in oil demand growth for the year lead the IEA to conclude that the balancing of the oil market seems within reach in the second half of the year or early 2017.
By James Stafford of Oilprice.com
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