Kemp: Feast Or Famine? Oil Market In 2018

Oil consumption is forecast to increase by another 1.4 million bpd in 2018, the IEA says (“Oil Market Report”, IEA, September 2017).

Global crude and product stocks are now drawing down rapidly owing to a combination of strong demand and supply restraint by Saudi Arabia.

Stocks are still above the five-year average, but converging towards it, and the five-year average is likely to prove too low given the prodigious growth in consumption since 2012.

The critical question is how quickly producers will respond to strengthening demand and tightening oil inventories.

With most producers already operating near full capacity, most output growth over the next two years will have to come from Saudi Arabia (and its close ally Kuwait), conflict-torn countries in Africa, or the U.S. shale sector.

Saudi Arabia has spare capacity, but will likely want higher prices before increasing its supply to the market, especially with the partial floatation of Aramco drawing nearer.

Nigeria and Libya also have spare capacity but the poor security situation in both countries makes future production increases highly uncertain.

U.S. shale producers can increase production, but their costs are rising, and they are coming under mounting pressure from shareholders to focus on improving returns rather than growing output.

What Next?

A range of scenarios is possible for the oil market in 2018/19:

• The rise in prices and move to backwardation could fizzle out if compliance with the OPEC production agreement declines and U.S. shale output rises rapidly, overwhelming demand growth.
• Prices and calendar spreads could remain rangebound, if OPEC exits its agreement smoothly and the rise in shale output matches the growth in demand.
• It is at least possible that prices will rise further and the backwardation will deepen if consumption growth outstrips supply and stocks continue to fall.

Many analysts and traders have backward-looking expectations, assuming the future will resemble the immediate past, which is why they tend to miss turning points.

Expectations were much too bullish after the boom years of 2011-2014, which is why many analysts and traders missed the impending slump, and then underestimated its depth and duration.

But it is arguable expectations have become too bearish in the aftermath of the slump and traders are now underestimating the prospects for recovery.

Of course, it’s always possible the market will have just enough supply, with shale and OPEC adjusting smoothly to match the increase in demand.

But if I were advising Pharaoh, I wouldn’t tell him to bet on it.

(Editing by Dale Hudson)