Supply/demand rebalancing some time away
The oil sector is firmly in a new cycle, with a dramatically lower cost profile across the industry. Inventories in the US remain at elevated levels (only just below last year’s record levels). Although demand growth is steady, the production growth from the US shales alone is seen to be enough to provide for this growth from (Q217-Q218), with OPEC playing a role as the swing producer to cover seasonal variation. The market agrees, and the forward curve has progressively lowered and flattened over the last 18 months. We lower our long-term oil price assumption to $70/bbl in 2022 (equivalent to c $60/bbl real in 2016).
The note is here
Steady demand growth of 1.4% in 2017-18
The IEA forecasts demand to be relatively robust in the coming 12-18 months, growing by 1.41mmb/d 2017-2018 (or 1.4%) driven by Asia. This annual growth (in absolute barrels) is similar to that seen in 2011-16.
Shales can deliver the required supply growth easily
Between 2017 and 2018, the growth in supply will overwhelmingly come from the US, with 1.1mmb/d (of the 1.4mmb/d demand growth) accounted for by the OECD Americas with other (non-OPEC) sources supplying 0.3mmb/d. As a result, to balance the market, the IEA forecasts that the call on OPEC will fall by 0.1mmb/d. These estimates put a stress on the performance of the US shales (which are that much more elastic to pricing over much shorter timelines than conventional production). Our analysis indicates the shales are well capable of delivering this increase, even if the rig count falls as much as 20% (assuming current productivity per rig). Reductions in rig count or productivity per well only really start to be felt in the 2018-2019 timeline, by which time the production would start to plateau, potentially opening up an environment for higher prices, albeit cushioned by the current high inventories.
Lowering our long-term oil price assumption
The IEA sees an extended period of ample supply, with non-OPEC supply alone growing more than global demand in 2018. The vast majority of this growth will come from the US, underlining the massive impact that the fracking revolution continues to have. Given the speed at which producers can alter activity levels, we continue to view the oil price through a shale lens. In the short to mid-term, therefore, prices need to incentivise further drilling to fill the estimated 1.8mmb/d growth in demand in Q2-Q417 (of which the IEA expects the US to supply the largest chunk). We retain our methodology of employing the EIA forecasts in the short term ($50.79/bbl in 2017 and $51.58/bbl in 2018). In the longer term, US shales are not enough to supply a growing global economy and prices need to encourage conventional development. However, the drop in development costs since 2014 has flattened the supply cost curve, leading us to reduce our long-term oil price assumption to $70/bbl in 2022 (equivalent to c $60/bbl real in 2016). Our previous assumption was $70/bbl real in 2016.
