OBSERVATION
TD Economics
June 22, 2015
PRICES OFF THEIR BOTTOM, BUT WORLD STILL
AWASH IN OIL
Highlights
• At its mid-year meeting, OPEC decided to leave output quotas unchanged, suggesting that it is committed to its fight for market share. Both OPEC and the U.S. continue to pump out oil at elevated
rates, driving the wedge between supply and demand even larger.
• However, output in the U.S. should begin to ease in the second half of this year and continue falling
in 2016 as the lack of investment since the price collapse begins to be felt on the production front.
While it will help to improve the market balance, it will take time to work down the massive glut currently in the market.
• As such, there is considerable risk for another leg down in prices in the coming months. Overall, we
suspect that expectations for an improvement in market dynamics will help to keep the WTI benchmark hovering around its current level of US$60 per barrel in the near term, before heading higher
to an average of US$70 per barrel in 2016.
It has been about a year since crude oil prices started to fall, and around six months since OPEC
decided that it no longer wanted to be the one to balance the global crude oil market, effectively controlling prices. This change of heart comes as the cartel has been losing market share since the rise of
shale oil production in the United States. As such, all eyes have been on the U.S. output numbers to
determine whether or not OPEC’s strategy is working. While the U.S. continues to pump out oil at near
record highs, rig counts have fallen dramatically and there have been some draws on storage in the last
few weeks, which has helped to lift prices. The WTI benchmark is now hovering close to the US$60
per barrel mark, up from the trough of US$43 per barrel hit in March.
The uptick in prices, however, has been driven largely by a reCHART 1: WTI CRUDE OIL PRICE FORECAST
versal in market sentiment rather than a change in market dynamics.
USD per barrel
Indeed, the world remains awash in oil, with production still far
120
outpacing demand. This suggests that OPEC’s strategy will need
more time to work. Moreover, given the glut that still persists, there 100
is considerable risk for another leg down in prices in the coming
months. Overall, we expect WTI to average just under US$60 per 80
barrel through the third quarter, before heading up to an average 60
of US$70 per barrel in 2016.
OPEC holding the line
At OPEC’s meeting on June 5th, the cartel decided to leave
output quotas unchanged, noting that the sharp correction in prices
due to the oversupplied market has now abated, with prices moving off their lows in recent months. It highlighted the fact that
Dina Ignjatovic, Economist, 416-982-2555
40
20
0
2012
2013
2014
2015F
Source: Haver Analytics, Forecast by TD Securities
2016F
TD Economics | www.td.com/economics
demand is expected to pick up in the second half of the year
alongside the global economy, while growth in non-OPEC
supply is expected to slow to a third of the pace recorded
last year. Pointing to global inventory levels sitting above
the 5-year average, the organization assessed the market as
‘comfortably supplied’.
OPEC is sending a clear message that despite the oversupplied market, it is not going to back down. Several
members would prefer higher prices (and need higher prices
to balance government books); however, the cartel is sticking with its strategy in the hopes of driving out higher cost
producers such as the U.S. shale oil producers.
On that front, while investment in the U.S. oil sector
has certainly taken a hit – impacting future production –
the strategy has yet to have a meaningful impact on output
levels. What’s more, with prices staging a bit of a rebound
to about US$60 per barrel, many projects are still profitable.
And, current futures prices – which have been higher than
the spot price – are providing incentive to store oil. The
U.S. has continued to ride the momentum of previous investments, which has led the country to account for 90% of the
total increase in non-OPEC supply since November when
OPEC revealed it would no longer be the swing producer.
But, market participants have been encouraged by the fact
that rig counts in the U.S. have been cut in half. In theory,
lower rig counts should translate into lower production levels. This will likely be the case eventually, but it will take
time to show up in production numbers given the increased
productivity of rigs as well as the higher initial production
rates and steeper decline curves – particularly when drilling for shale oil. As such, while output in the U.S. appears
CHART 2: U.S. CRUDE OIL PRODUCTION
AND RIG COUNTS
10,000
Thousands of barrels per day
Number of rigs
1,200
1,000
7,000
800
4,000
Jan-12
Jul-12
Jan-13
Source: Baker Hughes, EIA
June 22, 2015
15
10
5
0
-5
-10
2004
2014
2016F
Russia
China
Canada
Mexico
Brazil
Total Non-OPEC
Saudi Arabia
Kuwait
Rig Count (rhs)s
200
Jan-15
2012
North Sea
400
Jul-14
2010
United States
Crude Oil Production (lhs)
Jan-14
2008
to have levelled off, it will remain quite elevated until the
wells that are currently being drilled become depleted – signs
of which should begin to surface in the second half of the
year. Indeed, TD Securities expects American production
to fall modestly from its current pace of 9.6 million barrels
per day to 9.3 million barrels per day by year-end, and to
continue sliding in 2016, averaging (a still-elevated) 9.1
million barrels per day for the year.
Outside the U.S., production has been mixed among other
key non-OPEC producing regions; Canadian, Brazilian and
North Sea output has continued to trend up, while production in Russia and China has been relatively flat. Output in
Mexico and several smaller non-OPEC producing countries
has been drifting down.
OPEC, however, has turned on the taps in recent months,
accounting for about two thirds of the global supply increase
Iran
Jul-13
2006
Source: EIA, Forecast by TD Securities
600
6,000
5,000
Y/Y % Chg.
Y/Y % Chg. December-May
1,800
1,400
8,000
20
CHART 4: GLOBAL OIL PRODUCTION GROWTH
1,600
9,000
CHART 3: U.S. OIL PRODUCTION GROWTH
0
Iraq
Abu Dhabi
Venezuela
Total OPEC
-10%
-5%
0%
5%
10%
15%
20%
Source: Oil Market Intelligence
2
TD Economics | www.td.com/economics
since November. About half of this gain has come from
Saudi Arabia, where production has surpassed 10 million
barrels per day, marking a record high. Iraq has also been
ramping up production, a trend that is expected to continue
going forward. As a whole, the cartel has consistently been
pumping out more than the target quota, with the excess
over the last three months averaging about 1 million barrels
per day. Although a nuclear agreement is still uncertain at
this point, Iran is preparing to return output to pre-sanction
levels once a deal is reached and sanctions are lifted, which
will add even more oil to OPEC’s supply.
Global demand still trailing supply
Meanwhile, low prices have yet to trigger a meaningful pick-up in global consumption. Non-OECD demand
growth – which accounts for the bulk of demand growth –
has been slower than historical norms as several emerging
markets are struggling on the economic front. Oil demand
growth in China – which is the world’s second largest oil
consumer – has held at a steady 2% over the last 6 months,
much slower than the 6% average growth rate seen in recent
years. Meanwhile, demand in Latin America has been flat
over the last few months. On the flipside, one bright spot has
been India, where demand has grown 8.1% since November,
and the country has now displaced Japan as the world’s third
largest consumer of the fuel. The rise in demand is due in
part to refinery expansions in the country. Consumption in
Saudi Arabia has also been strong, averaging 3.4% growth
over the last six months.
In the developed world, the U.S. has been a key source
of demand growth, rising by an average of 2.8% (y/y) per
month since November. May was a particularly strong
month for the world’s top oil consuming country, as consumption was up 4.8% (y/y). In Europe, demand growth
was robust over the December-February period, but has
since flattened out. South Korean oil consumption has also
been growing rapidly, up 4.5% since November. Elsewhere
within the OECD countries, demand has been fairly weak.
Global oil glut persists
So while global supply has remained resilient in light of
low oil prices – up by an average of 4% y/y since November,
the increase in world demand has been half that rate. Hence,
the oil market is still far from balanced. The surplus in the
market grew to over 4 million barrels per day in May – the
highest level since 2005. This gap should begin to narrow
in the second half of the year, as demand picks up alongCHART 6: GLOBAL OIL SUPPLY AND
DEMAND GROWTH
6%
Y/Y % Chg.
5%
Supply
4%
Demand
3%
2%
1%
0%
-1%
-2%
Jan-14
CHART 5: GLOBAL OIL DEMAND GROWTH
5
Y/Y % Chg. December-May
United States
Apr-14
Jul-14
Oct-14
Japan
Apr-15
CHART 7: GLOBAL OIL SUPPLY-DEMAND
BALANCE
Million barrels per day
Quarterly
Forecast
4
OECD Europe
Jan-15
Source: Oil Market Intelligence
Excess Supply
3
Canada
2
South Korea
Total OECD-34
1
China
India
0
Saudi Arabia
-1
Former Soviet Union
Total Non-OECD
-4%
-2%
Source: Oil Market Intelligence
June 22, 2015
0%
2%
4%
6%
8%
10%
-2
Excess Demand
Jan-14
Apr-14
Jul-14
Oct-14
Jan-15
Apr-15
Q3-15
Q2-16
Source: Oil Market Intelligence, TD Economics
3
TD Economics | www.td.com/economics
side improvements in global growth and supply loses some
steam. Still, it will take time to work down the massive glut,
with the market unlikely to move back into a more balanced
position until the end of 2016.
Expectations for an improvement in the supply-demand
balance has likely been a driving force behind the change in
market sentiment, and resulting uptick in prices. However,
there are still some key risks in the oil market that could
lead to another leg down in prices. Storage utilization in
the U.S. is sitting at 88%, and space could become an issue
following the peak summer demand season when refineries
are idled for maintenance. What’s more, at over 57 days
supply, global inventories are at a record high. And, it appears as though more oil is being stored at sea, as demand
for supertankers surged in May. If production continues to
outpace consumption by a wide margin, storage around the
globe may become an issue as well.
In the meantime, the slight tightening in the U.S. oil
market – falling inventories – and loosening in the global
market has nearly wiped out the spread between the WTI
and Brent benchmark prices. This is unlikely to last, as the
decline in U.S. oil imports – largely responsible for the drop
in storage levels – is expected to reverse course in the near
term, thereby loosening the market somewhat. This should
lead to a widening in the differential over the second half
of the year and into 2016.
Bottom Line
There are two wild cards in the oil market: OPEC and
U.S. production. If both regions continue to pump out oil
at these rates, prices are likely to take a hit. It is clear that
OPEC has no intention of cutting production. Moreover,
if the potential increases from Iraq and Iran materialize –
although the prospects of the latter happening in the very
near future is questionable – OPEC’s supply could move
even higher above quotas, delaying any improvement in the
supply-demand balance and weighing on prices. So it will
likely be up to the U.S.to show some decline in production –
CHART 8: GLOBAL OIL INVENTORIES
58
Days supply
57
56
55
54
53
52
2013
2014
2015
5-year average
51
50
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Source: Oil Market Intelligence
which we do expect to happen in the coming months as wells
start to become depleted. We suspect that expectations for
a diminishing in the oil glut will help to keep prices around
current levels before heading higher to average US$70 per
barrel next year as actual signs of an improvement in the
market balance emerge.
We do caution that there are several factors that, if realized, could lead to another correction in prices and increased
volatility. These include higher production, storage capacity
constraints, geopolitical tensions, and slower-than-expected
economic activity in key consuming regions such as China,
the U.S. and Europe. Furthermore, if prices climb high
enough (on a sustained basis) to entice some higher-cost
producers to start ramping up output again – likely around
US$75-80 per barrel – prices will be subject to further bouts
of downward pressure as more production will be expected
to come on stream. All told, for OPEC’s strategy to work,
prices will have to remain below these production-enticing
levels for quite a while.
Dina Ignjatovic, Economist
416-982-2555
This report is provided by TD Economics. It is for informational and educational purposes only as of the date of writing, and may not be
appropriate for other purposes. The views and opinions expressed may change at any time based on market or other conditions and
may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a
solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The report does not provide
material information about the business and affairs of TD Bank Group and the members of TD Economics are not spokespersons for TD
Bank Group with respect to its business and affairs. The information contained in this report has been drawn from sources believed to
be reliable, but is not guaranteed to be accurate or complete. This report contains economic analysis and views, including about future
economic and financial markets performance. These are based on certain assumptions and other factors, and are subject to inherent
risks and uncertainties. The actual outcome may be materially different. The Toronto-Dominion Bank and its affiliates and related entities
that comprise the TD Bank Group are not liable for any errors or omissions in the information, analysis or views contained in this report,
or for any loss or damage suffered.
June 22, 2015
4