Oil market rebalancing Journey s end? JOHN KEMP REUTERS 3 Aug 2017
Outline Prices in long-run perspective Current position in the cycle Next steps on the journey Sources of uncertainty
What do we mean by oil market rebalancing? At least five elements Closer balance between supply & demand Normalisation of crude & product stocks Forward price curve Sustainable flat price Sustainable investment We will put aside for the moment the question of whether the oil market has ever been or will be in balance
Adjustment process is never smooth and straightforward The long and winding road Oil market is a complex system Low price responsiveness Long lags in investments Backward-looking expectations Multiple feedback mechanisms Multiple sub-systems Non-linear dynamics
Oil market is cyclical: no bust (or boom) lasts forever Best advice on oil business comes from Book of Ecclesiastes (Ch 3) To every thing there is a season, and a time to every purpose under the heaven: a time to be born, and a time to die; a time to plant, and a time to pluck up that which is planted; a time to kill, and a time to heal; a time to break down, and a time to build up; a time to weep, and a time to laugh; a time to mourn, and a time to dance; a time to cast away stones, and a time to gather stones together; a time to embrace, and a time to refrain from embracing; a time to get, and a time to lose; a time to keep, and a time to cast away; a time to rend, and a time to sew; a time to keep silence, and a time to speak; a time to love, and a time to hate; a time of war, and a time of peace.
Recent history of crude oil prices Stability, collapse, partial recovery
Oil price is low but not exceptionally so Current price is just about within post-2007 range
Oil prices are close to the full-cycle average Current price compared with Dec 1998 - Jan 2016
Real oil prices in long-run perspective (1) Oil price currently close to post-1973 average
Real oil prices in long-run perspective (2) Oil price currently close to post-1973 average
Current oil price near forecast average for 2017 Survey of 1000+ energy professionals in Jan 2017
Oil prices have been basically stable over last 12 months Market has discovered a new price range of roughly $45-55
Higher oil prices have encouraged resumption of drilling U.S. oil rig count has more than doubled (primarily in Permian)
Rising rig count has brought an increase in production U.S. output was up by around +315,000 b/d year-on-year in May
U.S. crude output forecast to rise +450,000 b/d in 2017* Forecasts have been revised higher as sector recovers * but a massive +770,000 b/d including NGLs
U.S. output forecast to rise another +570,000 b/d in 2018* Sensitive to assumptions about what happens next to drilling * but an enormous +990,000 b/d including NGLs
Rig count shows early signs of hitting a plateau Oil prices no longer rising, acting to dampen drilling boom
U.S. oil rig count up by just 2.5 per week in last 4 weeks Slowdown from average of 17 per week in late Jan/early Feb
Drilling is responding to the stabilisation of oil prices WTI prices now basically unchanged compared with year ago
Drilling typically responds to WTI with 4 month lag Lag is generally 16-20 weeks
WTI prices peaked in late Feb U.S. oil rig count seems to have followed in Jul
Oil prices have tapped the brakes on the drilling boom Moderating risk of oversupply in late 2017 and in 2018
Oil prices are regulating U.S. shale drilling Market has found breakeven, rigs idled <$45, re-activated >$50
Saudi-led OPEC is trying to accelerate rebalancing Exports curbed especially to highly visible locations
U.S. crude stocks draw earlier and faster than normal Crude stocks down -54 million bbl since late March (norm is flat)
U.S. crude stocks now on a downward trend Stocks below year-ago levels for first time since 2014
Refiner demand for crude has been consistently strong U.S. refinery runs have been at seasonal records since Apr
U.S. gasoline consumption running about flat with 2016 Record or near-record rate but not much growth
U.S. fuel stocks remain well contained despite record runs Strong demand in export markets including Latin America
Trade growth is key driver of mid-distillate demand Freight recession in 2015/16 depressed diesel consumption
Diesel/gasoil demand fell in 2016, first time since 2009 Only third time since 1990 (freight recession + warm winter)
Global trade is recovering in 2017 More freight movements will boost distillates and RFO demand
Oil traders now expect lower crude inventories in 2018 Prospective oil market rebalancing is reflected in calendar spreads
Rebalancing should see shift towards backwardation Past experience suggests contango will narrow and disappear
U.S. drilling and other services costs are starting to rise Service companies have warned cost compression unsustainable
Hedge funds are now less bearish but far from bullish Burned twice already this year, fund managers are cautious
Hedge funds net long crude by 550 million bbl Given structural net long of ~382mb, dynamic position just 167mb
Hedge fund managers running careful net long Ratio of long to short positions just 3.55
Revisiting some issues from earlier in the year Slides from Oil market rebalancing: the long and winding road given on 9 Feb 2017 with annotations
## Summary of current situation (1) OPEC tries to accelerate rebalancing process Crude oil market has been gradually rebalancing since early 2016 (Yes) Transition from oversupply in 2014/15 to undersupply in 2017/18 (Yes) Flat prices and calendar spreads both up significantly pre-opec (Yes) Compliance with OPEC deal appears good (mostly due to Saudi) (ish) Hedge funds have bought into OPEC s rebalancing narrative (Yes but got badly burned in Mar and May and now very cautious) Hedge funds pushed prices and spreads too far, too soon? (Yes)
## Summary of current situation (2) Some progress on draining stocks Crude stocks appear to be falling (Yes) Invisible stocks becoming visible (Yes) Supply & demand close to balance (Yes) Inventory overhang remains large (Yes though now drawing) Rebalancing seems to be happening (Yes question is now how fast) Slowly at first, likely to accelerate (Yes most cyclical moves accelerate)
## Summary of current situation (3) Strategic issues for OPEC Extension of output curbs probably necessary (Yes extended to at least March 2018) Uncertainty around reactivation of U.S. shale (Some uncertainty resolved as breakeven revealed to be around $45) Higher prices versus protection of market share (Saudi chose to sacrifice market share to push prices back up) Protection of relationships with refiners in Asia (Saudi sacrificed customer volumes to stabilise prices)
OPEC compliance and relaxation of output curbs (weakening) ## Summary of current situation (4) Key uncertainties in the medium term Uncertain timing of crude oil market deficit and stock drawdown (We have more information now about the timing/scale) Uncertain breakeven price of U.S. shale producers (cyclical costs) (Breakeven prices revealed at around $45) Uncertain breakeven price for oil majors and offshore (costs again) (Breakeven prices cut to roughly $50) Uncertain global economic outlook (Trump, Brexit, macro-cycle) (Remains major source of uncertainty) Uncertain recovery in commodity-dependent emerging markets (Emerging markets are stabilising if not growing again)
Oil market is now well on the road to rebalancing Sustained cyclical upswing is underway Remember supply-demand-price dynamics are very non-linear Recoveries tend to be slow and halting at first, then accelerate Costs will gradually escalate as supply chain tightens Transition from recovery phase to early expansion phase Scaling up U.S. shale production? Drilling beyond the Permian? Resumption of deepwater investment? Can big projects work at $50? OPEC+ compliance and exit strategy: market share back in focus? Macro-economic cycle is starting to look mature in OECD