OBSERVATION
TD Economics
May 25, 2017
OPEC AND NON-OPEC group agree to EXTEND
PRODUCTION CUTS
Highlights
• As expected, OPEC and the select group of 11 non-OPEC producers announced an agreement to
extend existing production cuts through the first quarter of 2018. Markets seem to have been hoping for something more, as prices are down 4% today.
• The overall success of this strategy depends on the response from producers who are not participating in the deal, particularly U.S. shale producers which have been quick to ramp up output over
this year. Even assuming further growth in non-OPEC production, signs that global inventories are
being drawn down should begin to emerge in the second half of the year, helping to drive prices up
to the mid-US$50 per barrel range.
Today, OPEC and the select group of 11 non-OPEC producers announced an agreement to extend
existing production cuts through the first quarter of 2018. The current agreement has not been as effective as hoped, and the group of producers remains committed to balancing the market and bringing
global inventories back in line with the five-year average. Under the new agreement, output quotas for
participating member countries will remain unchanged from that in the first half of the year.
Saudi Arabia and Russia signaled such a deal early last week, after concerns that the initial deal would
not be enough to balance the market sent prices down to US$45 per barrel. As such, the outcome of
today’s meeting was largely built into the market, although it appears as though markets were hoping
for a little something more. Prices are down by around 4% today, and currently sit just under US$50
per barrel.
The overall success of this strategy ultimately hinges on the response from producers not participating in the deal – particularly in the U.S. shale industry – which have thus far offset a good chunk of the
cuts. While shale output remains the wild card going forward, evidence of falling global inventories
should begin to emerge later this year, helping to lift prices toward the mid-US$50 per barrel range.
Compliance to remain high, but offsets to continue
When the initial agreement to curb production was announced, there was some concern surrounding
compliance, particularly among OPEC members. But, the compliance rate since January has been quite
high at 96%. The non-OPEC group has trailed behind, complying with less than half of the cuts, but have
been steadily improving each month. The group has indicated that they intend to reach 100% by June.
While there is some risk that compliance among the group may wane going forward – especially
since some maintenance was brought forward into the first half of this year to help meet targets – Saudi
Arabia’s oil minister continues to reiterate that they are committed to doing whatever it takes to restore
balance in the market. Moreover, so long as prices remain around or above the US$50 per barrel mark,
the incentive to comply will be there. One thing to keep an eye on is output from the two exempt countries, Libya and Nigeria, as production in both is expected to ramp up. This could offset a considerable
chunk of the total OPEC cuts, requiring others – namely Saudi Arabia – to cover the difference.
Dina Ignjatovic, Economist, 416-982-2555
@TD_Economics
TD Economics | www.td.com/economics
While prolonging the production curtailments will
certainly help get the market on the path to rebalancing,
the agreement only comprises about 60% of global supply,
leaving a significant part of the market free to increase output, and does not take into account any potential weakness
in demand.
Of the joint 1.8 million barrel per day production cuts
agreed upon, nearly half has been offset by higher output
elsewhere – particularly in the U.S. where shale production
has been quick to ramp up. Indeed, production in the U.S.
has reached 9.3 million barrels per day, the highest level
seen since August 2015. Canada, Brazil and the North Sea
have also recorded increases this year.
This trend is set to continue, with Canada, Brazil and
the North Sea on track to increase production further this
year as new projects ramp up. But, much of the focus will
be on the biggest wild card: U.S. shale output. Production
in the U.S. is set to continue its recent uptrend, as oil rig
counts in the U.S. have more than doubled from year-ago
levels and are back to levels not seen since early-2015. In
fact, total U.S. production could surpass the previous high
of 9.6 million barrels per day (mid-2015) before the end of
this year. Moreover, many producers have hedged through
the end of this year and into 2018 which will keep output
propped up regardless of where prices move. On net, global
oil supply is expected to rise by around 1 million barrels
per day this year.
Demand growth to fall short of last year’s pace
Meanwhile, demand growth during the first quarter was
softer than expected, driven in large part by the U.S. – the
CHART 1: U.S. PRODUCTION AND RIG COUNTS
10,000
Thousand barrels/day
Number of rigs
1,800
1,600
9,500
1,400
9,000
1,200
1,000
8,500
800
8,000
600
7,500
400
U.S. Production (lhs)
200
Rig Count (rhs)
7,000
2014
2015
Source: Baker Hughes, EIA. TD Economics
May 25, 2017
2016
2017
0
CHART 2: GLOBAL OIL INVENTORIES
64
Days Supply
62
60
58
56
2015
2016
2017
5-year average
54
52
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Source: Energy Intelligence, TD Economics
world’s largest consumer – where lower gasoline consumption and unusually warm temperatures slowed overall oil
consumption growth. As such, global supply continued
to outstrip demand, and recent efforts to curb production
have yet to make a meaningful dent in global inventories.
In fact, inventories remained at record levels in the first
quarter, sitting at 63 days supply.
While demand is expected to pick up over the remainder
of the year, the annual growth in consumption will likely
fall well short of last year’s 1.7 million barrel per day
increase. After a soft start to the year, momentum in the
U.S. and China is expected to build, in line with growth
in their overall economies. China has already started to
show signs of improvement with record crude oil imports
in March, while a seasonal uptick in the U.S. as the summer driving season kicks off should lead to higher overall
oil consumption stateside. Elsewhere, demand is unlikely
to pick up meaningfully, leaving overall demand growth at
around 1.3 million barrels per day.
All told, demand should slightly outpace supply growth
this year and signs that the rebalancing in the global oil
market is underway should emerge toward the latter part
of this year.
Prices gains to be limited
But, don’t expect a huge rally in prices. As evidenced
by the drop in prices today, the impact of the extension in
production cuts is already largely priced in, and there is
still a massive glut of inventories that need to be worked
down before prices can move sustainably higher. As well,
the supply response to higher prices has been fairly swift
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CHART 3: NET LONG POSITIONS ON THE NYMEX
600,000
Number of contracts
120
500,000
US$/barrel
Forecast
100
400,000
80
300,000
60
200,000
40
100,000
0
Jan-16
CHART 4: CRUDE OIL PRICES
20
Jul-16
Jan-17
Source: Haver Analytics/CFTC, TD Economics
– mainly in the U.S. shale industry – and will likely keep
a lid on prices until stockpiles return to more manageable
levels. Markets have put a lot of focus on U.S. stockpiles,
which have begun to come down, but remain well above
the 5-year average.
What’s more, prices are influenced by more than simply
supply-demand fundamentals. Crude oil is now as much a
financial instrument as it is a commodity and risk appetite
can have a considerable impact on prices. Non-commercial
net long positions on the NYMEX – a benchmark for speculative activity – were quite elevated in late-April, leaving
the market vulnerable to any deterioration in risk sentiment
surrounding crude oil – one that materialized and sent prices
down sharply in early-May as short covering took hold.
Net long positions are currently sitting at the lowest level
since just before the current production cut agreement was
announced.
Today’s agreement should provide investors with
some solace that several key producers are committed to
eliminating the supply glut and that the path to rebalancing
0
2012
2013
2014
2015
2016
2017F
2018F
Source: Haver Analytics; Forecast by TD Economics as at May 2017.
remains underway. Hence, the fundamental picture should
gradually improve sentiment toward oil. However, risks
remain tilted to the downside, as production both within the
OPEC/non-OPEC group and outside could be higher than
anticipated and demand growth could remain soft. Moreover, risk appetite is also influenced by factors outside the
oil market, and with a number of uncertainties around the
globe – particularly surrounding the political environment
stateside – volatility is likely to persist.
Bottom Line
All told, an extension of the current production quotas
is certainly warranted, given that the restraints to date have
yet to have a meaningful impact on global inventories. But,
ultimately, the success of OPEC’s strategy will depend
largely on how much of these cuts are offset by production elsewhere, as well as demand. If the compliance rate
remains high, signs that the global oil market is moving
toward a more balanced position should surface in the second half of this year, helping to lift prices to the mid-US$50
per barrel level.
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May 25, 2017
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