The headlines reacting to OPEC’s April Oil Market Report generally read “OPEC concerned about global oil demand” and as such, oil prices traded down slightly on April 13, despite an overall positive market.
Well, I’m concerned about global oil demand also, so I thought I better read their report. Clearly, the commodity never performs well in the face of stagnant or shrinking economic activity – no commodity does – in fact, nothing does. Except maybe alcohol sales. In any case, I am concerned with exactly how worried OPEC was about global oil demand and by extension, global GDP growth. Guess what? It turns out that despite the green lobby’s insistence, world economic activity is strongly reliant on hydrocarbon consumption and vice versa.
Anyway, what I found in the report was not so much concerns about GDP growth in various regions of the world, although these are expressed and reviewed, but rather the underlying prediction of a massive rebound in oil and gas activity during the second half of 2016! By extension, for non-OPEC production to rebound, the cartel must be assuming much higher oil prices beginning, well, about now.
Is this foreshadowing that a big production cut deal will come out of the Doha Qatar meeting this weekend? Probably not. In any case, I keep thinking, what if OPEC told us oil prices were going up sharply, but they buried the news deep in an 85 page report and nobody noticed?
Maybe they did. However, the fact is OPEC did not mention surging oil prices or sharp increases in exploration and production activity in their report, but they implied it. As subtle as the implications were, those commentators that managed to read only the first page summary of the report failed to grasp its true meaning. But in fact, to make the numbers add up, the only explanation is that OPEC is very bullish on both oil prices and oil service activity. Let me explain.
First it’s necessary to set the backdrop by reviewing oil and gas fundamentals at a 50,000 foot level. Overall, OPEC is expecting that global growth in oil demand (really all liquids demand) in 2016 will average 1.2 million barrels per day (mb/d). That is, demand will average 94.2 mb/d vs the 93 mb/d average in 2015.
So here is where I start to sense that OPECs monthly oil market report and reality have, let’s say, diverged onto different paths. OPEC details how production is essentially falling all over the world after achieving strong growth in 2015. In particular, non-OPEC supplies grew by 1.5 mb/d to reach 57.1 mb/d in 2015. In 2016, noting the aforementioned large drop in CAPEX and the corresponding rig count, non OPEC production is expected to fall by nearly 800,000 bpd.
In both cases, U.S. tight oil is leading the way. In particular, U.S. tight oil volumes are falling the fastest. They note that in March, these volumes are expected to be down over 700,000 bpd from their peak in the first quarter of 2015. They also note the falling rig count as a major driver, possibly leading to increasing rates of production declines during 2016. Got it – rig counts drop to the lowest levels since the 1980s, production falls hard. Especially in tight oil where new wells typically decline by 75 percent in their first year of production. No brainer there. Most analysts have realized this.
However, what about the current oversupply you ask? Are they not just saying that the market will just absorb the excesses of a currently oversupplied market? Yes. However, based on their own estimates, the market is basically in balance today. As such, here is where their projections start to deviate from logic – or to suggest a rebound is upon us. Below is OPEC’s forecast of non-OPEC production by quarter. The group notes that the world has seen a sharp drop in oil production during the first quarter of 2016. Various sources have already reported much of this information. Importantly, OPEC is predicting larger decreases in production in the second quarter of 2016 as the drop in activity that accelerated last December, really starts to impact production. Once again, this is starting to be accepted by those that pay attention to the data. These declines have recently garnered some press attention and I believe played a role in the recent oil price rebound.
This is all as expected – the global oil industry cannot grow volumes in a $30/bbl oil world. In fact, at that price, cash flows are insufficient to warrant investment even to the levels necessary to replace production – much less grow volumes. Many have been saying this and dropping production is the evidence that they are correct.
However, fast forward to OPEC’s estimate for third quarter 2016. They predict flat production relative to the second quarter. Further, in the fourth quarter, they predict non-OPEC production growth!
As such, the only way OPEC can make these projections is through sharply rebounding oil prices. Further, to make these numbers, this has to begin now. So in reality, maybe they are telling us without actually telling us, that they are about to hit us with a price shock.
I don’t think so. I think they want to avoid any such messy outcome. However, we can recognize that the correction process is happening. But the rebound in investment is nowhere in sight making it unlikely that volume declines suddenly stop and then reverse in the second half of 2016. What this really tells me is that prices got out of control, dropped much further than the cartel expected, but they couldn’t reverse course without losing credibility. Maybe we all will be better off when they just leave markets alone.
Full article: OPEC Report Suggests Massive Oil Price Rebound (OilPrice)