Solid Demand for Crude Oil Unlikely to Save Prices


Image result for organization of the petroleum exporting countries (opec)The energy sector was a rollercoaster ride in 2017, with peak-to-trough moves of 25-35%. A similar volatile year awaits investors in 2018, as we expect oil supply to outpace growth in demand and oil prices to slide in the high single digits.

At the end of 2018, Brent and West Texas Intermediate (WTI) crude prices likely will stand at $57 per barrel and $53 per barrel, respectively, based on our estimates. We foresee a balanced oil market this year, following an estimated deficit of 0.5 million barrels per day (mbpd) in 2017.

Demand is not an issue, and we expect it to expand 1.4 mbpd after a 1.6 mbpd rise last year. This would be the fourth consecutive year of above-trend growth. Emerging Asia (+0.9 mbpd) will be the driver of the demand growth, in our view, with slightly more than 40% of global incremental demand expected to come from China and India (each +0.3 mbpd). However, we see global supply growing at an even stronger pace (+1.9 mbpd) in 2018, following below-trend growth of 0.4 mbpd in 2017.

Supply from nations not part of the Organization of the Petroleum Exporting Countries (OPEC) will likely contribute 1.3 mbpd, with the US expected to deliver an additional 1 mbpd (0.7 mbpd crude and 0.3 mbpd natural gas liquids) in 2018. We also project higher production in Canada and Brazil (up collectively by around 0.3 mbpd). Moderate production gains in Kazakhstan and Russia will likely be offset by declines in Mexico and emerging Asia.

As we foresee oil inventories from the Organisation for Economic Co-operation and Development (OECD) at the five-year average around mid-2018, we expect OPEC crude output to gradually trend higher during the second half of the year. For OPEC oil production, we expect an increase of 0.6 mbpd in 2018 (0.4 mbpd crude and 0.2 mbpd natural gas liquids). A moderate OPEC production increase is achievable and will fall into the hands of the OPEC Gulf Cooperation Council (GCC) countries (i.e. Saudi Arabia, Kuwait, and the United Arab Emirates) in the second half of 2018. These are the OPEC members that have made significant voluntary cuts.

Venezuela, meanwhile, is unlikely to increase production in 2018, in our view, and production is down nearly 0.4 mbpd since mid-2016. Rather, a further drop is likely, considering the fragile state of the economy and the lack of investments in recent years.

Globally speaking, with the oil market expected to move from a deficit into a balanced environment this year, we see oil prices weakening over the course of 2018. The need for lower prices comes from the necessity to keep the supply from non-OPEC producers, such as US shale, in check. Oil prices around $60-$70 per barrel could set the tone for a renewed inventory build. Despite attractive roll gains in crude oil, elevated speculative positions in crude oil futures are an additional risk factor to consider.

But there are some scenarios -so called risk scenarios will lower probabilities than our base case above- in which oil prices could move higher. New international sanctions or destabilizing political events in oil-producing countries could resulting in a possible drop in supply of 0.5-1.5 mbpd. In such a scenario, Brent could trade close to $80 per barrel.

Meanwhile, a breakdown of the OPEC+ production cut deal could move oil prices lower, as could a faster-than-expected increase in US crude production and less demand growth if Asia slows unexpectedly. Brent could trade at $40-$50 per barrel if these scenarios materialize.


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