Oil things considered:Cutting through the oil industry data:
Brent crude hit a YTD high in September, and prices continue to stabilise at muchimprovedlevels.。
Brent crude has recovered by ~USD10/b from its June low. While the weakness inthe US dollar has undoubtedly been a factor, we think price strength also reflects anumber of pointers that the oil market continues to rebalance.
US production jumps +332kb/d in a week
Inventories are continuing their steady downward trend. US commercial stocks arenow only 8% above their five-year average vs 21% at the peak in February, whilelatest (August) OECD data shows a halving of the surplus since the start of this year.。
The strength of demand has been a key feature with 2Q17 y/y demand growth thestrongest since mid-2015. While 3Q demand will be adversely affected by the recentUS hurricanes, 2017 still looks set to be an extremely strong year.
US data are starting to look much less constructive this week. As US crudeoil production crosses the 10mmb/d mark, the most recent monthly survey(EIA-914) data has thrown another curveball, this time to the upside of Novemberweekly and model estimates. In some sense, this is an 'overcorrection' from thedownward deviation seen between April and August 2017, Figure 1. Stripping outAlaska and GoM gives a similar result, Figure 2. Although the pace of monthlysurvey supply growth could slow before accelerating again in September, thispoints to the role of production in the generally positive inventory error term,averaging +283kb/d since November. This, along with an unexpectedly (andunsustainably) large +332kb/d increase in crude oil production (w/e 2Feb), ishelping to counter bullish sentiment.
OPEC supply was broadly flat in September, with compliance at well over 80% but anet cut of only 0.5mbd after factoring in the recovery in Libya. The OPEC agreementto rein in supply is scheduled to run to end-1Q18, but there are signs that keymembers are edging towards extending it to year-end 2018.。
US production is set to continue growing strongly for now, not least thanks to a likelyfall in the number of drilled uncompleted wells (DUCs). However, after a >140% jumpfrom its 2016 lows, the US rig count peaked in August and has since fallen slightly.
But growth likely to moderate
The US oil rig count has stalled and is now down 3% from its August peak.Meanwhile, productivity data still shows average productivity per rig flat-to-down inaggregate, with increases in the Bakken a notable exception. The rate of wellcompletions is still growing, but it is not yet matching the pace of wells drilled so thenumber of drilled, uncompleted wells (DUCs) continues to rise。.Latest weekly data was affected by precautionary hurricane shut-ins, but the priorweek’s data showed US crude supply up 1.0mbd y/y, and total supply (includingNGLs) up 1.2mbd. However, latest revised monthly data for crude is showingvolumes around 200kbd lower than this, and October’s Drilling Productivity Reportsaw another downgrade to Eagle Ford production estimates. Nevertheless, thestrong momentum of US tight oil supply should continue for now, not least ascompletion activity catches up and DUCs fall. However, we remain convinced thathigher prices than current levels are needed if this momentum is to be sustained inthe longer term.。
This reinforces our view that current rates of US supply growth are unlikely to besustainable longer term without a material rise in US crude prices from recent levels.
In November, US monthly crude oil production rose by 384kb/d, of which 209kb/d was a Gulf of Mexico recovery from Tropical Storm Nate evacuations, and172kb/d attributed to onshore Lower 48production growth. This pace of growthkeeps the monthly survey data on a surprisingly rapid growth path.
We think the market needs sustained long term growth in US tight oil supply in orderto fill an impending supply gap as conventional non-OPEC output starts to decline inthe next few years. An extension of the OPEC cuts through 2018would help keepthe market tight until that point is closer to reality. Our Brent price assumptionsremain US54.4/b for 2017e, rising to USD65/b for 2018e and USD70/b for 2019e.。
OPEC supply fell slightly in August with improved compliance and a drop in Libyanoutput from its recent peak, but the net cut vs pre-agreement levels is still less than0.5mbd. The OPEC agreement runs to end-1Q18, but we believe it could beextended if global inventories remain in excess by that stage.
Contrast current growth with the Mar-Sep 2017period, when onshore supplygrew at an average of 45kb/d/mon. Then between Sep-Nov 2017, growthaveraged 262kb/d per month, Figure 3. Because the Drilling Productivity Reportmodel doesn't indicate any such shift from low gear into high gear, we expect thepace of supply growth will moderate towards some middle ground. The +1,174kb/d pace of growth implied by the January DPR works out to a monthly pace of+98kb/d, which we think is more sustainable.
Recent US inventory data is hard to interpret given the effects of the hurricanes, butit is clear that a significant amount of the global surplus has been eliminated. As ofend-July, the OECD inventory surplus stood at around 7% vs the five-year average,vs 12% at the peak early this year.
Supply boost from high prices to come later
We remain convinced of longer-term upside to crude prices. With the lack of newmajor project sanctions, we expect conventional non-OPEC supply to start decliningpost-2018. Even with growth in OPEC supply, we think this points to the need forsustained growth in short-cycle US tight oil well beyond 2017-18 in order to meetglobal demand. Without materially higher prices in the longer term, we are notconvinced that this sustained growth is deliverable.
The weekly supply bump comes much too early for us to characterise it as a resultof WTI oil prices reaching the USD 61-65/bbl range cited as a key level whichwould accelerate drilling activity, according to a Federal Reserve Bank of Dallassurvey of 125oil and gas executives. This is because we would typically expect a3-4month lag between oil prices and drilling activity, and a further 6month periodbetween drilling and production reaching the market. With WTI prices havingcrossed USD 61/bbl on 3January, this puts the activity boost in April, Figure 4,and the resulting supply surge around October. Nonetheless, our extrapolation ofcurrent data points into the end of the year suggests US inventory will remainbroadly supportive of price, Figure 5, as it maintains a yoy decline.
We have marked to market our 3Q Brent price assumption, bringing it down fromUSD54/b to USD52/b. This brings our FY17e assumption down from USD55/b toUSD54.4/b, but our longer-term assumptions remain unchanged at an average Brentprice of USD65/b in 2018e and USD70/b in 2018e. While any reversal of the recentUSD weakness would pose downside risks to prices in the short term, we think thefundamentals are becoming increasingly supportive.
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