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Osama Rizvi

Osama Rizvi

Osama is a business graduate and a student of international relations. Currently working as freelance journalist, covering commodities and geopolitics.Osama is a regular contributor to a variety…

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Are Oil Markets Ignoring Demand?

To the surprise of many, the OPEC and NOPEC deal is not only holding but overperforming. The compliance rate stands at 91 percent, with the recent OPEC Oil Market Report declaring a total cut of 890,000 bpd. Saudi Arabia has been cutting more than it initially promised. Russia has reduced some 100,000bpd in the month of January. This would seem to paint a promising picture for the future of oil markets, only a month and a half into the production cut agreement and the prices have been moving to and fro in the $50-$60 band. There is a catch however, of-late the market is basically focusing on two things, short-term movements and supply. But it is ignoring the most significant factor responsible for driving oil prices upward - demand.

The IEA released its Oil Market Report on February 10, 2017. It was certainly bullish but with a flash of caution. The report showed that “OPEC crude production fell by 1 mb/d to 32.06 mb/d in January, leading to a record initial compliance of 90 percent with the output agreement. Some producers, including Saudi Arabia, cut supply by more than required. Lower production was partly offset by higher flows from Libya and Nigeria, which are exempt from cuts.” Moreover, the Paris based agency has predicted that NOPEC output will grow by 0.4 percent in the current year (2017). This is due to three main factors. First, and most importantly, U.S. Shale. Due to the rise in oil prices the U.S. nodding donkeys are busy pumping black gold from the ground. The rig count has increased year over year, now standing at 591 rigs as per the latest Baker and Hughes rig count report. Second, countries like Libya and Nigeria continue to increase output. Third, oil exploration and production deals are returning to the market as investors pour money back into the sector. The IEA predicts a growth of 175,000bpd in U.S. production this year. Related: Why Sub $50 Oil Is More Likely Than $70 Oil

The IEA has increased its outlook for demand to 1.4mbpd – a near-insignificant increase of 0.1 percent from its last report.

Mr. Leonid Bershidsky, a BloombergView Columnist, very rightly observes that “The developed world's commercial oil stocks dropped in January, but they still stand at around 299 million barrels above the five-year average. If the stocks fell by the entire amount of the January production cut, it would take them 200 days or more, depending on whether the IEA or OPEC got the size of the cut right, to get them to that average level. Of course, the stocks won't fall this quickly because the market is not balanced yet”.

It may be that we are focusing on the wrong side of the equation. The effect of these short-term speculations and production cuts will be offset by lower demand and the increase in U.S. shale production. The story remains the same. This is a dilemma, a vicious circle to which there is no end. In another article No Refuge for Oil the writer explains the above situation as: What, then, is the panacea? I am afraid there is none. The markets have to wait. Patience is the key here. If the OPEC and NOPEC producers remain true to the Vienna Deal - which is only for the first six months of the current year - it may still take a year for the oil glut to drain. But a very relevant condition for this drainage to eventuate is demand, and it looks to be waning. China’s economic growth is not looking very promising. This price cap may, in the future, effect the compliance of oil producers if they do not see any positive impact from the deal.

It certainly is a test of patience. Patience for demand to once again step in.

By Osama Rizvi for Oilprice.com

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  • Justin on February 16 2017 said:
    How is China not looking promising? Numbers of late show otherwise and attention should also go to India as well.
  • Matthew Biddick on February 16 2017 said:
    Demand is waning? Let's see, global demand at the Q1 of 2009 was about 84.5 mmbopd. The EIA's STO recently put demand for Q1 of 2017 right at 97 mmbopd. That's an average yearly increase of over 1.5 mmbopd. The last five years average has been "only" 1.4 mmbopd, so maybe I should give you the "waning" adjective after all. The only reason that global demand was met over the course of the last 8 years was that for the first 5 of those 8 years the oil price was about double what it is now. That enabled a temporary supply cushion to be established, too. I'm not sure the next 5 years demand growth can be met unless oil prices rise much higher than they are now.
  • Osama on February 17 2017 said:
    Justin: The demand in China is looking down...even if you see the numbers. Its GDP growth is expected to go down...also few months back it was reported that its inventories are at almost full level. Yes, India is looking good...so are the other Non-OECD coutnries. I remember reading about that how the global share of these countries will grow in the future...but the thing is that demand from "only" India isn't enough to suck up the excess supply. Shale is a major issue....
  • Osama on February 17 2017 said:
    Matthew: I agree....But I have used the phrase of 'demand is waning' in a sense that the renewable(s) are also starting to eat up the share of black gold.
  • James Eastman on February 21 2017 said:
    Good article. My personal opinion is that, regardless of short-term trends, sooner or later oil prices will rise, for these simple reasons:

    1.Oil demand is still growing and has grown hugely in the last ten years due to increased demand from emerging economies. Up until now, the impact of renewables has been insufficient to prevent this and is unlikely to do so in the next ten years.

    You could argue that humanity's rising reliance on oil from 84.5 million barrels per day in 2009 to around 97 today was reckless global irresponsibility. For all the 'shale revolution' hype, the last year discoveries exceeded production was 1980.

    It is also reckless irresponsibility that allows the majority of the capital 'invested' in the oil industry to go into speculating on futures and derivatives as opposed to actually bringing oil out of the ground.

    Short-term glut aside, barring global conservation measures and huge development of alternative energy sources, the day of reckoning will eventually come and it won't be pretty.

    2.There has been inadequate investment in bringing in new supply. The glut we are experiencing now was due to a surge of new investment around 2008 when oil peaked at over $100/barrel. Discovery rates are down and current wells are depleting.

    Even if there was another surge of investment in discovery today (impossible given current crude prices), new oil fields cannot be bought into production overnight-it takes years to assemble personnel/material required, spud the wells and bring in/build the new infrastructure required.

    My prediction is that sometime in the next 5 years (probably in the next 2-5), demand will outstrip supply again and prices will inevitably rise. There may well be another price shock in the magnitude of 2008, due to the years of under investment in new production and the lag time between finding new sources and bringing them online.

    At that time, the repercussions for the already stagnant and over-leveraged Global economy may not be so good.

    However people who shrewdly invested in carefully selected oil producing companies (especially small and mid-cap producers) during the bust, may do very well for themselves.

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