Demand is stable
The report says three countries are expected to contribute nearly 60 percent of increases in global oil demand in Q2 2018, with China contributing 28 percent, the United States 14 percent and India 15 percent. These three countries, says the report, will also be the main growth drivers beyond Q2, significantly contributing to OPEC’s forecasted yearly global oil demand growth of 1.63 million barrels per day in 2018 Despite 2018’s growth being comfortably higher than the annual average rate seen in the last ten years, the report notes two important points. First, the latest revision for March 2018 is the eighth revision to oil demand since OPEC first published its 2018 forecast in July 2017. March 2018’s forecast is 370,000 barrels per day, higher than the July 2017 total. Second, despite the sizeable increase in oil demand expected in 2018, this level of growth still represents a second consecutive annual decline.
Last month, the United States imposed tariffs on Chinese steel and aluminium imports, which was swiftly countered by China imposing higher duties on some U.S. goods. Although oil prices were pressured towards the end of Q1 2018, the report suggests the fallback was motivated more by investor sentiment, rather than any direct impact on oil demand itself. Currently, the fear is that the U.S. government may institute further protectionist trade measures, leading to heightening trade tensions between the two largest economies. Such trade tensions would have inevitable negative effects on global growth and would put significant pressure on oil prices.
OPEC compliance continues
OPEC data shows that crude oil production from its members averaged 32.1 million barrels per day in Q1 2018, showing no change quarter-on-quarter. Overall, in Q1 2018, OPEC’s total output was 1.5 million barrels per day less than the organisation’s October 2016 output, the reference point for the production agreement. Venezuela’s production declines continued into Q1 2018, helping the country inadvertently achieve cuts in excess of 400 percent to its agreed level. Venezuela is still battling an economic crisis, meaning oil revenues will continue to be diverted to government revenue, leaving very little cash for capital expenditure to reverse a decline in oil output.
Looking ahead, the report says the biggest factor affecting OPEC output in Q2 2018 is likely to be related to whether or not sanctions are re-applied on Iran. In May, the US president will decide whether or not to waiver the current nuclear deal, which could have a sizeable impact on output and oil prices. The report says any return to sanctions would have the most extensive and immediate impact on oil markets. However, although combined US and European Union (EU) oil sanctions removed more than 1 million barrels per day of Iranian oil exports between 2011 to 2015, the report says it would be less this time since the EU is not as keen to implement sanctions. That said, European customers may still be forced to scale back purchases of Iranian oil, if US sanctions are re-applied, since this would make financial transactions with Iran more complicated and riskier.
Meanwhile, Russia, another major contributor to the current production agreement, has also kept oil production steady. Data from the Russian Ministry of Energy shows that crude oil production averaged 10.96 million barrels per day in Q1 2018, with no change from the previous quarter. In the past, the reports notes, some privately owned oil companies expressed their unease over the production agreement with OPEC, but recently disclosed financial results tell a different story. According to full year 2017 earnings data from five companies, which together account for about 76 percent of total Russian crude oil production, combined net profits rose by 46 percent, or about $5 billion, year-on-year. Such a sizeable rise in profitability, despite overall Russian oil output declining in 2017, provides an incentive for such companies to continue engaging in cuts.
The Joint Ministerial Monitoring Committee
In the recent past, the report says, the idea of extending OPEC and non-OPEC oil output cooperation into 2019 was aired for possible discussion at the up-coming Joint Ministerial Monitoring Committee. The reason for the extension would be to lower commercial oil stocks which have been rising since late 2014. However, latest OPEC data shows that OECD commercial crude oil stocks are now trending down towards the five-year average, which somewhat weakens the argument for an extension to an output agreement. More recently, the argument for extending OPEC and non-OPEC cooperation seems to have moved towards incentivising upstream investment. According to the International Energy Agency (IEA), at current oil demand growth rates, and factoring in oil field depletion rates, the global oil industry needs to replace around 3 million barrels per day of oil every year, for the foreseeable future, in order to avoid a price spike. The main concern is that the current levels of upstream capital expenditure, after dropping significantly in recent years, may not be sufficient to avoid price volatility in the next few years. As a result, the reports says, the upcoming JMMC may see some participants pushing for continued cooperation in order to maintain oil prices at a level which encourages a rebound in upstream capital expenditure and, in turn, provides security against future price cycle volatility.
Quarterly oil price outlook
Brent oil prices averaged $67 per barrel in Q1 2018, up 8 percent quarter-on-quarter. The report suggests rising optimism around global economic growth, continued OPEC compliance to output targets and rising geopolitical tensions all contributed to pushing prices to levels not seen since Q4 2014. Although oil prices were pressured somewhat at the start of April, due to trade tensions between China and US, they have since rebounded, as regional geopolitical tensions have become more predominant. Looking ahead into the remainder of Q2 2018, the report says the biggest factor affecting oil prices is likely to be related to whether or not sanctions are re-applied on Iran. In fact, according to officials from the National Iranian Oil Company (NIOC), if sanctions were re- applied and 400,000- 500,000 barrels per day of Iranian oil was removed from the market, oil prices could jump to $80 per barrel or more. With year-to-date Brent oil prices averaging $67 per barrel and likely to remain elevated in the near term due to continued regional geopolitical tensions, there is a sizeable upside potential to the current Brent oil price forecast of $60 per barrel.