In 2017, U.S. crude oil inventories have increased for nine consecutive weeks to start the year. Rising U.S. inventories have created concerns that OPEC production cuts were not happening. However, declines in U.S. oil inventories in late March revived oil prices a bit. We expect U.S. crude oil inventories to continue to decline throughout the second and third quarters. The focus of the oil markets has now shifted to the OPEC agreement.
To date, OPEC compliance is much higher than most expected. In March, OPEC countries collectively reduced production by more than the 1.2 million barrels per day associated with the agreed upon cut and year-to-date through March 2017, OPEC’s average compliance with its stated production cut was around 98%.
Non-OPEC compliance with the stated production cut was not quite as good, though it is improving. Recall that non-OPEC countries, mainly Russia, agreed to cut production by approximately 600,000 barrels per day for the first six months of 2017. Non-OPEC suppliers cut production by 64% of this stated goal in March, the highest percentage of compliance achieved so far in 2017. With spring weather now upon us, we expect Russian cuts to accelerate since there is less risk curtailing production in warmer temperatures. We expect this to have a positive impact on crude balances and market sentiment.
In the upcoming May OPEC meeting, we expect members to conclude that production cuts and price stability is headed in the right direction and will continue to focus on returning the level of global inventories to the five year average, from the current 300+ mmb surplus. Meeting this threshold is unlikely by May, and is the basis for our view that an extension of the OPEC coordinated cuts is more likely than not. There may be some rhetoric from OPEC member countries with a threat to not to extend the agreement, but we believe this would largely just be an attempt to improve a negotiating position.
U.S. Stands to Benefit from OPEC Production Cuts
Given the U.S. is now home to more than half of the OECD inventory overhang, we expect a pick-up in exports of crude oil from the U.S. in 2017. And we believe the global market has sufficient capacity to absorb additional U.S. volumes without being disruptive to the rebalancing process. The EIA outlook for U.S. production has continued to tick higher with 2017 average production now expected to increase 340 mb/d. And as rigs continue to ramp, exit-to-exit production increases of ~860 mb/d in 2017 are expected. This increased level of production will likely require additional takeaway infrastructure, in particular to the Gulf Coast for export.
Is There a Sweet Spot for Commodity Prices?
Our oil price forecast remains in the $50-$60 per barrel range. It is a true sweet spot for U.S. producers and also for consumers of oil-related products. We do think $50 per barrel oil is a line of demarcation in today’s market. If oil prices fall below $50 per barrel for an extended period of time then U.S. producers will likely reduce their capital budgets and slow production growth. In our opinion, global oil inventories need to be reduced to keep oil prices stable. The International Energy Agency or IEA still expects the global oil market to be undersupplied in the second quarter resulting in declines in global oil inventories. Global oil demand growth typically accelerates in the second half of the year so if OPEC extends its production cut agreement through the end of 2017 then we would expect global oil inventories to decline at a faster rate in the third and fourth quarters of 2017, approaching normal levels by year end.
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