Monthly Future Oil Price Road Map
by Paul Kuklinski
July 12, 2018
Timing Differences Impacting Oil Price Psychology
The recent peak in oil prices reflected the anticipated loss of supply from Libya, Iran, and Venezuela, downtime in Canada, and looming pipeline bottlenecks in the Permian Basin. But future supply is being augmented by the response of Saudi Arabia and its allies, new OPEC capacity coming on line, and a Permian surge in 2H19, while there is increasing risk of slowing growth in world oil demand. Oil prices are sensitive to changes in the outlook for market balance.
On fear of shortages, WTI crude spiked to a recent high over $75/B in early July and is now $70/B. It averaged $68/B in 2Q18 and $51/B for all of 2017. Brent hit a peak of $81/B in May and is now $74/B. Brent has greater geopolitical sensitivity.
Recent upward pressure on oil prices is likely to ease after peak summer demand passes in September, with increased supply from Saudi Arabia and its allies. Downward pressure is likely to emerge in the spring as winter demand passes and the coming surge in production from the Permian Basin approaches.
Saudi Arabia and its allies appear to be targeting a $70-75/B Brent price. Absent a geopolitical crisis, WTI is expected to average $67/B this year, with a $5/B Brent premium, and $68/B WTI in 2019, with a $4/B Brent premium.
Spot Gulf Coast gasoline prices were $2.02/gal in 2Q18, up 32% from 2Q17. Low sulfur diesel prices were $2.10/gal, up 43%. WTI was up 41% from 2Q17. Current US gasoline inventories are 6% above the 5 year average but distillate inventories are 12% below, which is an improvement from 23% below a week ago. Refinery runs ramped up to 96.5% of capacity in June to keep up with seasonal demand. After a decline in June, 2Q18 Gulf Coast refining margins were still an attractive $9.07/B compared to $9.32/B a year ago.
Unplanned supply disruptions removed over 2 MMBD from the market in June. By OPEC’s estimate, OECD inventories were 40 MMB less than the 5 year average in May, down from a record surplus of 380 MMB larger than the 5 year average in 1Q16. The OECD accounts for 48% of world oil demand. The IEA calculates the OECD deficit at 23 MMB. In June, US inventories were 16 MMB less than the 5 year average.
Oil prices higher on lost supply which is not gone forever
Libya’s output plunged in late June when 5 eastern ports which handle 850 MBD exports were closed. A Benghazi-based militia in conflict with the UN backed government in Tripoli assumed control. Exports are said to have resumed 2 days ago. Libya is scheduled to hold an election `late’ this year. Rivalry between factions and militias continue to periodically disrupt its production.
With the port closure, Libya’s production fell to around 520 MBD, down from 1010 MBD in 1Q18. Almost all of production came from the western part of the country and some offshore fields. The impact of a 500 MBD reduction in Libyan production is equivalent to a sizable quarterly reduction in OECD inventories of 45 MMB if it persists for 3 months.
In late June, the US announced it expects Iran oil buyers to cut imports to 0 by November in response to renewed sanctions. China is currently importing about 635 MBD, India 650 MBD, Japan 165 MBD, South Korea 245 MBD, Europe 650 MBD. Consensus estimates seem to indicate a steady increase in the amount to be removed in 2H18 to the 1 MMBD range at the end of the year, an equivalent quarterly reduction in OECD inventories of 80 MMB when reached in 1Q19. The IEA warns of a 1.2 MMBD reduction.
At the same time, demonstrations against Iran’s domestic policies have emerged. Its economy is heavily dependent on oil exports. As its economy weakens further, unrest and the pressure on its economy is likely to increase into mid 2019. The outlook for Iran is unstable and unpredictable.
Iran produced 3.80 MMBD crude oil in June, relatively flat with 4Q16 at the time of the OPEC cut but up from 2.91 MMBD in 2015 before sanctions were lifted. Its oil exports were 2.12 MMBD in 2017 compared to just 1.13 MMBD in 2015 when sanctions were in effect. In anticipation of renewed sanctions, April exports jumped to 2.62 MMBD but fell to 2.39 MMBD in May. In addition, Iran exports about 300 MBD of condensate. It accounts for almost 5% of world oil supply.
In an attempt to force oil prices higher, Iran threatened closure of the Strait of Hormuz through which shipments of crude oil from Saudi Arabia and its allies move to world markets. The US Navy stated in response it would keep the Strait of Hormuz open.
The continued decline in Venezuela’s production appears to be slowing. It produced 1.30 MMBD in June, down 720 MBD from a year ago. It is expected to decline by 135 MBD in December and continue to decline at a similar rate through 2019. It suffers from a lack of maintenance, spare parts, and electrical failures. Skilled employees have left the country.
New OPEC supplies are on the way
Saudi Arabia and its allies are responding with increased production. In June they agreed to an increase of 1 MMBD from May levels which would offset about 60% of the anticipated 1.635 MMBD decline in supplies from Iran and Venezuela by next year and the loss of Libya if its eastern ports remain closed.
India said the Saudi oil minister assured him that Saudi Arabia “along with other producers will ensure availability of adequate supplies to offset any potential shortfalls and ensure that prices remain reasonable.” India imports 80% of its crude requirements.
At the same time, OPEC’s current spare capacity will be reduced from 3.42 MMBD in May to 2.36 MMBD which supports a bullish view on oil prices. But several OPEC producers are adding 4.8 MMBD capacity from 3Q18 to 2025.
Saudi Arabia produced 10.49 MMBD in June, a 470 MBD increase from May. It has indicated it would produce up to 11 MMBD in July to relieve market shortages. It produced 9.96 MMBD in 2017, and 10.55 MMBD in 4Q16 when the OPEC cut was announced. Its capacity is 12.04 MMBD.
Angola produced 1.43 MMBD in June. Its capacity is 1.58 MMBD. The start up of the deepwater Kaombo Field in July-August will ramp up to capacity of 230 MBD over an 18 month period.
The UAE produced 2.90 MMBD in June. Its capacity is 400 MBD larger at 3.3 MMBD and is set to increase to 3.5 MMBD by the end of the year.
Kuwait produced 2.73 MMBD in June. It plans to increase its output by 65 MBD. Its capacity is 2.83 MMBD. In addition, it is reactivating the 300 MBD offshore Khafji Field in the Partitioned Neutral Zone it shares with Saudi Arabia. Production has been shut since October 2014. The 200 MBD onshore Wafra Field in the PNZ has been closed since May 2015. Restarts in both fields are expected to take months. Kuwait is planning to increase its crude production capacity to 4 MMBD by 2020.
Iraq produced 4.53 MMBD in June. Its capacity is 4.80 MMBD. In addition, expansion of the West Qurna Field will add 150 MBD by the end of 2019 and 1.6 MMBD by 2025. West Qurna produced 881 MBD in May. Iraq aims to have 8 MMBD capacity in 2025 with 6 MMBD from its southern Basra province, the rest in the north. Iraq has a contract with BP to study expansion of the northern Kirkuk Field from 500 MBD to 2 MMBD.
New production caps will be set in September by a 6 country monitoring committee chaired by Saudi Arabia and Russia.
Russia produced 11.46 MMBD in June and plans to add 200 MBD in July. It may take 6 months to add more. It produced 11.58 MMBD in 4Q16 when it agreed to join OPEC in cutting production. A large number of new greenfield projects will raise Russia’s capacity to about 12 MMBD in 2020.
There is a timing gap about 6-12 months between the full impact of the expected loss of 1.00 MMBD or more Iranian crude exports due to renewed sanctions and an even larger 1.22 MMBD surge in production in the Permian Basin.
Permian oil production was 3.28 MMBD in June, up 872 MBD in the last 12 months. Limited growth is expected in coming months due to constraints on pipeline takeaway capacity. The addition of 2.3 MMBD new pipeline capacity next year in the 3rd and 4th quarters however, will allow production to surge to about 4.5 MMBD at year end by some estimates.
Another 600 MBD pipeline capacity will start up in 2020 and Exxon is planning 1000 MBD pipeline for late 2020/2021. Permian oil production in 2019 is likely to average around 4.00 MMBD, up 700 MBD over 2018. Long term forecasts anticipate a 2019 Permian production exit rate of 5.42 MMBD and a 2020 exit rate of 6.03 MMBD.
Total US crude and liquids production was 15.07 MMBD in June, up 1.75 MMBD in the last 12 months. It is projected to grow 1.40 MMBD by 2Q19, before the surge in Permian production. A 230 MBD increase is expected in the Bakken, a 245 MBD increase in the Eagle Ford, a 210 MBD increase in the Gulf of Mexico, and the rest nearly flat. Gas liquids are expected to increase about 380 MBD in the next 12 months.
Over the next 12 months, the growth in US production will be 88% as much as the expected 1.60 MMBD growth in world oil demand.
In Canada, an electrical outage closed the 360 MBD Syncrude oil sands upgrader on June 20th. Restoration of partial production is expected the end of July and full production in September. The shutdown resulted in a scramble for supplies by Midwest refiners and a narrowing of the Brent spread to WTI.
Canada’s oil production increased 348 MBD last year to 4.82 MMBD, 55% from oil sands, 25% conventional crude, and 20% gas liquids. Its production is now expected to increase 230 MBD this year to 5.05 MMBD with the ramp up of oil sands projects sanctioned in prior years and the start of the Hebron Field off Newfoundland last November, which will add 150 MBD at peak in early 2019. Canada’s 2019 production is expected to average 5.30 MMBD, up 270 MBD from this year.
Canadian producers are dealing with pipeline constraints as well. Western Canada’s 4.2 MMBD pipeline network is full, with crude by rail moving another 150 MBD. New pipelines with combined capacity of 2.54 MMBD could be on line by 2020 if various regulatory impediments can be resolved. Western Canadian Select crude sold at a discount over $22/B to WTI in 1H18, out from a $12/B discount in 2017.
Despite much higher oil prices this year, there is still no sign of growth in other non OPEC production. Outside North America and Russia, other non OPEC production is expected to average 28.86 MMBD this year, up 44 MBD from 2017, following a 22 MBD decline in 2017, and a 1.15 MMBD decline in 2016. It is expected to be relatively flat in 2019. The 1H18 international rig count was 971, up 2% from a 2017 average of 948, which was down 1% from 2016. The international rig count peaked 38% higher at 1337 in 2014.
Despite Libya, Iran, and the rest, global oil inventories will increase
There are sizable normal seasonal changes in world oil demand which temporarily magnify or reduce the impact of changes in supply. The IEA currently estimates oil demand will increase by 500 MBD sequentially in 3Q18 from 98.80 MMBD in 2Q18. It is then expected to increase by 700 MMBD in 4Q18 before falling 800 MMBD in 1Q19. Its forecast then anticipates an 1100 MBD seasonal increase in 2Q19 and 600 MBD in 3Q19.
Given its demand forecast, current trends indicate OECD inventories will increase 33 MMB in 3Q18, 26 MMB in 4Q18, and increase again by 46 MMB in 1Q19 with the seasonal decline in demand even with the loss of Iran and no recovery in Libya. The data then indicates a decline of 10 MMB in 2Q19 and a small increase in 3Q19 with the ramp up of Permian production. Based on this data, the production response of Saudi Arabia and its allies is in line with indicated market demand. They will, however, have to remain proactive in response to unexpected changes in the market including a recovery in Libya.
The growth in world oil demand is likely to be less
After an increase of 1.49 MMBD in 2017, the IEA is estimating world oil demand will increase 1.43 MMBD in 2018 to average 99.15 MMBD, with a further 1.35 MMBD increase in 2019. Its estimates have downside risk.
Over many decades, there has been a clear link between oil prices and fuel consumption growth rates, first in gasoline and then in distillates, which become the primary driver in the second phase.
IEA analytics calculate a 10% increase in expected oil prices reduces global demand about 400 MBD. Brent reached $81/B in May, which represents a 60% increase from $50/B in 2Q17.
Demand growth slowed sharply in China, India, and the US in 2Q18. Combined, they account for 41% of world oil demand. US demand is expected to increase 260 MBD in 2019 following a 530 MBD increase this year.
The IEA also estimates a world oil demand reduction about 690 MBD with a 1% cut in global GDP growth in response to widespread rising trade tariffs. The impact would primarily hit bunker fuel consumption and inland transportation of goods, reducing fuel oil and diesel use.
About Boston Energy Research
Boston Energy Research selects equity investments in the oil and gas sector for major financial institutions.
Paul Kuklinski, founder of independent research firm Boston Energy Research, typically publishes over 30 common stock recommendations annually from a universe comprising the 5 super major integrated oils, 17 of the largest exploration & production companies, and 9 of the leading oil service providers including marine drillers, a total of 31 of the most important energy stocks in all. His comprehensive coverage provides a unique vantage point to observe industry trends not generally available.
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