The Organization of Petroleum Exporting Countries and its partners, notably including Russia, delivered an outcome on May 25 of extending, rather than deepening, their supply restraint agreements for another 9 months to the end of March 2018.
The policy decision failed to reignite the excitement seen last November when it was first introduced. Clearly, the market is worried about OPEC's ability to restore the balance.
Bringing inventories down to their 5-year average has proven a primary goal of OPEC's deal so far. Despite record compliance with oil output cuts reported by OPEC, global oil stockpiles and export levels from Saudi Arabia and other OPEC members have remained high. However, the commitment did succeed in establishing a new floor for prices that's well above the lows seen last year.
With the current extension, Saudi Oil Minister Khalid al-Falih expected OPEC to achieve its goal of returning global oil inventories to their 5-year average by yearend. But he highlighted that there are currently too many variables in the market to accurately predict, with high confidence, what the actual outcome from this agreement will be in terms of observable inventory declines.
Inventory drivers
US oil production will likely be in full bloom, driven by the pace of weekly rig count expansion. Without possibility of doing a government-level deal limiting US output, OPEC seeks to hinder US shale growth by keeping just enough supply on the market to hold prices below $60/bbl.
"For all OPEC members, $55/bbl and a maximum of $60[/bbl] is the goal at this stage. So is that price level not high enough to encourage too much shale? It seems it is good for both," said Bijan Zanganeh, Iran's oil minister. Noureddine Boutarfa, who represented Algeria at the meeting, noted that, at $50-60/bbl, the US oil industry can't break beyond 10 million b/d.
OPEC also bets that US production increases will not offset OPEC cuts despite rig count growth and swelling well inventories. However, a concern of the market is that OPEC may underestimate the potential US production response.
An ultimate market saver may appear in 2019 with the inception of a meaningful and durable production decline of the international non-OPEC supply. But production in 2017 and 2018 is expected to stagnate or increase slightly, due to continued major project startups and ensuing production tails.
Meanwhile, there are risks that Libya and Nigeria production might be rising sustainably, threatening the output cut.
So, to bring global crude inventories back to a 5-year average by yearend, the primary thing OPEC is counting on is a pick-up in demand, especially over the coming months.
Although remaining on a decelerating trend compared with 2016 and 2015, global oil demand growth is forecast to be steady in 2017. Global oil demand will rise 1.3 million b/d in 2017 to 97.9 million b/d, according to IEA's latest estimates. China demand remains strong.
In addition to production cuts and demand growth, there are some near-term catalysts that can contribute to falling crude stocks in the next few months, including a ramp-up in global crude oil runs. Starting in March, refinery activity is building up and by July, global crude throughputs will have increased by 2.7 million b/d, according to IEA.
Moreover, OPEC may plan to purposely reduce exports to the US to force a reduction in the latter's sizeable inventories. Saudi cargoes to the US in recent months have totaled 1.2 million b/d-the highest rates since 2014.
The most recent data from IEA showed that inventories from the Organization for Economic Cooperation and Development have already started to decline, and the stock draws are likely to be even greater in the second half of this year. Even if this turns out to be the case, whether stocks at the end of 2017 could fell to the 5-year average is still a question. Al-Falih noted that an extension of cuts beyond March 2018 was a possibility if inventories have not been restored to more normal levels.
"We'll cross that bridge when we get to it," he said.