Prices enjoyed a boost last week from encouraging inventory reports. Both the EIA and the API reported large draws on crude inventories, signaling that demand appeared to be catching up with supply in the short term. The reports arrested the week-long route in prices, which had tumbled below $46.
Some analysts, including those at Goldman Sachs, are encouraged that the market is balancing out, albeit more slowly than expected. Demand is anticipated to exceed supply in the short term, encouraging investors to bet on tight supply this year, thanks to OPEC and non-OPEC supply cuts.
But the real story is in demand, which is still uncertain. Vitol, the world’s largest independent oil trader, told Bloomberg that demand isn’t growing as quickly as expected, while growth in U.S. output continues to exceed expectations. Amidst OPEC cuts and surging U.S. shale, the market looks to demand to boost prices, “but there’s no growth,” according to one Vitol executive.
Much has been written on the OPEC production cuts and their weaker-than-expected effect on prices. But sluggish demand may prove to be just as important. The IEA has already reduced its expectations for demand growth in 2017 by about 100,000 bpd to 1.3 million bpd. The Paris-based group pointed to lower consumption in OECD countries and surprisingly weak economic activity in Russia and India.
China, which drove the boom in energy consumption worldwide for years, is showing signs of slowing demand. Import quotas for independent refiners have dropped since last year, indicating a reduction in the country’s energy needs. In January Bloomberg speculated that lower refinery quotas indicated plans to reduce purchases this year, a sign that demand would be weaker than expected.
China’s total oil demand hit a three-year low in 2016, a trend that won’t be reversed in 2017 as the breakneck economic expansion of the last twenty years continues to slow down. Related: Goldman’s Two Conditions For A Successful OPEC Deal
While Chinese oil demand grew in the first quarter of 2017, showing a 5.3 percent increase from 2016, this was chiefly to fill stocks before the refinery maintenance season began in March. Domestic production has slowed while imports shot up in the early part of 2017, but that trend may not last as the country relies on stockpiles and refinery imports slowdown. Right now it’s not clear if Chinese demand growth will prove bearish or bullish in 2017, or the following year.
Not all demand outlooks are gloomy. The EIA recently updated its forecast for 2017 demand to 1.56 million bpd, an increase of 70,000 bpd from its earliest estimates. OPEC, having revised demand forecasts for China upward, estimates total growth in demand for 2017 to be around 1.27 million bpd.
U.S. shale is adding between 400,000 and 500,000 bpd in total supply, but that won’t be enough to meet yearly demand increases of 1 million bpd or more. That’s the opinion of Chevron CEO John Watson, who argued that it’s going to take substantial investment in deepwater drilling and other new sources for future demand to be met---and that the massive drop in such investment presaged a major tightening of supply in future years.
That’s long been the IEA’s opinion. The agency has pointed to the calamitous drop in exploration and investment in new production since the price drop of 2014 as a sign that future demand will exceed supply, generating a new boost in prices.
A final indicator of demand growth this year is the expected boost in U.S. gasoline demand that usually accompanies the summer driving season. If OPEC extends its production cuts past June as expected, it will put greater pressure on U.S. shale to supply the demand surge of the summer months.
OPEC is betting that U.S. gasoline demand will cut into inventories and drain the remaining supply from the market faster than shale producers can replace it, sending prices back up. This week’s inventory reports may be the start of the long-expected draws that prove OPEC right.
But while crude inventories fall, gasoline inventories have continued to rise as refiners put out more and more product. Crude inventories fell by 1 million barrels, while gasoline stocks went up 1.5 million barrels, surprising analysts who had expected a steep drop. This has led to three straight weeks of falling gas prices in hubs like Houston, at a time of the year when prices usually rise.
In April it was reported that consumption had begun dropping after two years of steady increases, a flattening that Reuters attributed to improving fuel economy, bad weather and the timing of public holidays.
Total U.S. gasoline consumption fell in 2017 by 3 percent in the first quarter, compared to a 6 percent in 2016 and a 3 percent increase in 2015. The combination of rising inventories and sluggish consumption could see gasoline prices stay at historic lows all summer long.
In China and the U.S., two of the world’s largest energy consumers, there’s uncertainty over whether demand in 2017 will exceed supply and bring prices back up. Despite the surge in shale production and the likely extension of OPEC cuts, it’s possible the supply glut will persist throughout the year. Prices may stay below $50 as a result.
By Gregory Brew for Oilprice.com
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