Next week will mark the third anniversary of OPEC’s 2014 Thanksgiving Surprise, our name for the day after the American Thanksgiving holiday that year when the cartel decided it would not make production cuts to offset burgeoning production from the United States and balance global oil markets. That decision was the “shot heard ‘round the world” in the oil price war that sent the industry into the most severe downturn since the early 1980s.
OPEC is scheduled to meet on November 30, the last 2017 meeting when it will decide to extend current production quotas or make cuts.
Insiders remain optimistic, maybe too much so. Recent moves above $55 per barrel for West Texas Intermediate (WTI) have some of my industry friends hoping that happy days may soon be here again. The hope is strong that they might see just one more oil boom allowing them to retire (real oilmen never really retire, by the way).
Enough talk, let’s take a look at the data and trends.
Oil price trend or just speculation?
At October 30, 2017, the year-to-date average price for WTI near-month futures was $49.58 per barrel. In November the benchmark price appeared to have found support at $50 per barrel and on November 6 it broke resistance at $55 and is testing a higher support level at that price. On November 14, the near-month futures price for WTI closed at $55.70 per barrel and WTI has averaged $56.16 month-to-date, or 13% higher than the year-to-date average through October.
Is the recent oil price rally indicative of a turning point and that the long-awaited upward trend has arrived?
We believe that possibility is unlikely.
On the plus side, it is a bullish sign that U.S. crude oil stocks have set a downward trend since March 2017, but they are still high by historical standards. On November 10, 2017, U.S. crude stocks stood at 459 million barrels of oil, down from 490 million barrels last year, but still 42.1 million barrels above the five-year average. Additionally, the days of supply has fallen to 28.3 days on November 10, 2017, down from 31.2 days last year.
If current trends persist, we can see U.S. production hitting 10 MMBopd in 2018, driving U.S. oil exports to new highs.
OPEC crude stocks have been trending down as well. OPEC reported in its November 2017 Oil Market Report, “The excess overhang has fallen considerably, with the difference to the five-year average reduced by around 183 million barrels since the beginning of this year to stand at 154 million barrels in September.”
The downward trend in U.S. and OPEC oil inventories is good, but oil storage remains well above five-year averages, which translates into the fact that the world’s oil needs are currently well-supplied.
Turning to production, the increase in U.S. oil output is an offset to the bullish downward trend in crude oil inventories. For the week ending November 10, 2017, the U.S. Energy Information Agency (EIA) reported that U.S. oil producers pumped at the rate of 9.6 million barrels per day (MMBopd), 964,000 barrels more than the same week last year for an increase of 10%. If current trends persist, we at Prism Investor see U.S. production hitting 10.0 MMBopd in 2018, driving U.S. oil exports to new highs.
In a recent Industry Insider, we noted how U.S. drillers are using the crest above $50 per barrel to opportunistically layer on more crude oil hedges to protect cash flow and capital budgets for next year.
On the OPEC side of the supply equation, the cartel estimated it produced 32.6 MMBopd in October 2017, relatively flat to the 2016 average, with nearly one-third produced by Saudi Arabia. Gains in Iraq, Iran and Nigeria offset large declines in Venezuela.
The cartel’s production discipline appears to be fairly strong, and despite what must be frustration with non-OPEC producers motivated by free market economics, we expect continued restraint from the cartel.
U.S. industry response
As we noted in May 2017, the U.S. oil industry has responded to the new era of price stability in predictable capitalist fashion. As U.S. drillers put on more hedges, the rig count has increased and the result has been rising production from completing DUCs (drilled, but uncompleted wells) and drilling new wells.
We anticipate the U.S. rig count to continue rising into 2018, driving U.S. production higher.
Global oil fundamentals
Just a few days ago, on November 14 the International Energy Agency reported that it too is forecasting growth in oil demand, but “…our changes to demand growth, which remains robust, and supply largely cancel each other out. Using a scenario whereby current levels of OPEC production are maintained, the oil market faces a difficult challenge in 1Q18 with supply expected to exceed demand by 600 thousand barrels per day followed by another, smaller, surplus of 200 thousand barrels per day in 2Q18.”
In other words, IEA also expects U.S. shale developers to stand-up more rigs over the Permian Basin and American oil exports will continue to grow, which will be more than enough to satisfy rising global demand and will consequently slow the reduction in crude oil inventories.
In our view, what’s driving the recent run-up in oil prices is a combination of unfounded optimism driven by the decline in oil inventories combined with renewed geopolitical risks.
EIA reported in its Short-Term Energy Outlook for November 7, 2017 that global supply and demand fundamentals have largely come back into balance. Savvy observers will note that achieving supply-demand equilibrium is just the first step in re-balancing global oil markets. As noted earlier, oil stocks remain high and until inventories burn off, there is no need for the oil markets to send a higher price signal to industry.
What’s really happening with oil prices
In our view, what’s driving the recent run-up in oil prices is a combination of unfounded optimism driven by the decline in oil inventories combined with renewed geopolitical risks. Rumors of a regional hot war in the Middle East began to percolate in early November and on November 5, Saudi Arabia intercepted a missile fired at the capital city Riyadh, which lent credibility to the speculation. That is approximately when WTI broke above $55 per barrel. The missile was fired from neighboring Yemen by the Houthi rebels, who are aligned with Iran, the kingdom’s arch-enemy. The attack fueled worries that a hot war was on the verge of breaking out between the two Islamic standard bearers, which would have serious implications for the free flow of oil out of the Arabian Gulf (or Persian Gulf, depending on your political sensibilities).
Given the Saudi’s restrained response in the days following the missile attack, oil prices have come off their fear-induced highs. Consequently, we attribute the recent price rally to regional geopolitical concerns and not a sign that overall sentiment has changed to a demand-driven market from one that is supply driven.
On the third anniversary of the 2014 Thanksgiving Surprise, we do not expect another one and reiterate our thesis from May, that Saudi Arabia and the cartel will maintain a policy of price stability and OPEC will extend current production quotas.
With the Saudi Aramco IPO on the horizon in 2018, higher defense spending to combat the growing threat next door in Yemen and the need to fund its economic diversification program, the kingdom can ill afford another price war with U.S. oil shale producers. However, given the ability of U.S. operators to quickly increase production it will take more time before rising global demand outstrips the industry’s supply response, burns off high crude oil inventories and sets the stage for a long-term upswing in oil prices.
We anticipate some profit taking in the wake of the meeting, as it becomes clear that the oil markets are still supply-driven and we are a ways off from inventories reaching more average levels.