Oil lost ground in the last few days on slipping OPEC compliance rates and fears of persistent oversupply. But the tightening of the oil market is still proceeding, and there are some signs that the more pessimistic projections about oil prices could be overblown.
On Monday, as oil prices dipped, analysts attributed the drop off to the appreciating U.S. dollar. But while the immediate catalyst shifts from day-to-day, the forecast for the next few quarters remains the same: the inventory overhang might not go anywhere because the OPEC cuts are offset by rising production elsewhere.
For example, the bullish demand figures from the IEA last week were shrugged off because they are “only marginally above the current level of OPEC output,” according to Commerzbank analysts. “In other words, there will no longer be any significant supply deficit in the second half of the year, so there is hardly likely to be any further inventory reduction,” Commerzbank said in a research note. No change in inventories; no change in oil prices.
But a lot of the assumptions regarding an ongoing state of oversupply are based on the swift return of U.S. shale, plus rising production from Libya and Nigeria, all of which will roughly offset the production cuts made by the rest of OPEC. The rising rig count in the U.S. will lead to more production, it is assumed, “casting doubt on rebalancing efforts,” JBC Energy said. “We expect the total liquids balance to return to a more pronounced surplus over 2018, bringing with it a return to stock builds and a firm lid on prices,” JBC wrote.
However, those production gains are not a given. Take Libya for example. The North African OPEC member is exempted from the production cut deal, and it has gone a long way to restoring lost output. Most recently, Libya added more than 150,000 bpd in July, taking its output above the 1 million-barrel-per-day mark. But that output, not to mention further gains, is fragile.
Over the weekend, Libya’s largest oil field – the Sharara – saw its output slashed by a third because of protests at the Zueitina export terminal, which interrupted shipments. That pushed Sharara’s output down from 300,000 bpd last week to just 200,000 bpd. That came after a separate disruption last week, which only lasted for a few hours, at the oil field itself. “After months of boosting oil production, Libya currently seems to be experiencing output disruptions,” said Michael Poulsen, an analyst at Global Risk Management Ltd., according to Bloomberg. Related: Oil Rises, But Saudis Face Daunting Dilemma
Meanwhile, hundreds of protestors stormed an oil facility owned by Royal Dutch Shell in Nigeria last week, which could interrupt Shell’s Bonny export terminal. Niger Delta communities have long been incensed that they see little benefit to the region’s crude oil production, a situation that shows no sign of changing. Nigeria suffered heavy disruptions last year from attacks in the Niger Delta, and the fragile peace seen so far in 2017 could unravel at any moment. Shell’s troubles in recent days are a clear sign that instability could return at any point.
So, we can’t assume that Libya and Nigeria will continue to add supply. But what about the U.S., where things are stable and shale continues to ramp up? That is where an even bigger potential surprise lurks.
In the Permian, there have been some troubling reports in recent weeks that shale drillers are slowing down and having problems with their existing wells. The decline rate is accelerating and some wells are producing a higher gas-to-oil ratio than expected. Pioneer Natural Resources’ disappointing figures from the second quarter have sparked some concern that the Permian might not live up to the hype.
It remains to be seen if Pioneer’s struggles are indicative of a broader trend in the region. Analysts such as Wood Mackenzie are waving away concerns about the Permian – in a new report, the consultancy sees Permian production growing by another 300,000 bpd by the end of the year.
But the fact is that most analysts are assuming very strong production growth from the U.S. – the EIA sees output surging from 9.3 mb/d in 2017 to an all-time high of 9.9 mb/d next year. These gains are baked into everyone’s forecast, including OPEC’s. It is entirely possible that the shale surge starts to sputter, which would upend production assumptions for the rest of this year and into 2018. Related: Brazil’s Pre-Salt Extraction Costs Fall To $8 Per Barrel
Then there is Venezuela. Nobody knows what the immediate future holds for imploding South American country, but the direction of the country’s oil production is clearly negative. The only question is how quickly output will fall. The recent announcements from international companies withdrawing their personnel from Venezuela are a bad sign. Chevron, Total and Repsol have begun to reduce their number of workers in Venezuela, although it is unclear what that will mean for oil production. Still, the Trump administration could still push Venezuela over the edge with harsh sanctions, which could lead to a downward spiral in output. Some market watchers say that if things get bad enough, PDVSA’s oil workers might stop showing up to work.
In short, there is no shortage of supply risks to the market. If the gains in Libya and Nigeria start to reverse, U.S. shale undershoots, and Venezuela loses production at an increasing rate, then the oil market could look a lot tighter towards the end of this year than everyone assumes.
By Nick Cunningham of Oilprice.com
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