Energy Goldilocks? Growing Oil Demand, High OPEC Compliance Meet High Inventories and Growing Non-OPEC Output
Oil market dynamics set a supportive price range for producers and consumers. Oil exploration and production companies and oil services firms, share prices of which have fallen since their December peak, look appealing in this environment.
The International Energy Agency (IEA) Friday reported the best compliance on an oil output cut agreement in the history of the Organization of Petroleum Exporting Countries (OPEC). While this is supportive for oil prices, the IEA also noted faster-than-expected recovery in non-OPEC production, largely U.S. shale oil, which along with excess inventories should keep a lid on oil prices.
That sets up a nice equilibrium in prices: not too hot, which would spur more production, and not too cold, which would push higher-cost production offline. A stable market helps consumers and producers, both OPEC and non-OPEC.
In its February Oil Market Report, the IEA estimated OPEC’s compliance with its January production quotas at a record-setting 90%, driven by swing-producer Saudi Arabia, which along with a couple others actually cut more than they had bargained for. Others cut much less; Venezuela, for example, failed to reach even a fifth of its agreed-to reduction. Then there are Nigeria and Libya, both OPEC members, though they weren’t party to the November agreement because domestic security issues were already undercutting their production. But the two still managed to ramp output last month, so if their numbers are included compliance was actually just 60%, according to a Bloomberg survey. Nonetheless, “this seems to be one of the most successful agreements in terms of compliance,” IEA executive director Fatih Birol was quoted as saying. He added, though, that “there’s a second story: strong growth coming from the non-OPEC countries who are not part of the agreement.”
Non-OPEC output is seen climbing 400,000 barrels per day (b/d) this year, led by the U.S., Canada and Brazil.
Global oil inventories, meanwhile, are expected to shrink 600,000 b/d through June, albeit from elevated levels, if OPEC continues to hold firm on its quotas. And on the demand side, the IEA expects a 1.4 million b/d increase this year on a pick-up in global economic growth. Taken all together, the IEA still expects the market to rebalance in the second quarter.
After jumping on the Friday report oil prices closed largely unchanged, with WTI at $53.85 a barrel and Brent at $56.61. On Monday, February 13, both benchmarks were trading close to 2% lower.
Emerging Views considers a $50 to $70 per barrel price range a very good environment for exploration and production companies as well as oil services providers. Plenty of cash flow means plenty of activity. We also think a stable price environment helps service and E&P firms maintain good cost discipline, helping incremental revenues flow to the bottom line. It’s worth noting that, despite the supportive dynamic from OPEC supply discipline and the upward revision to IEA demand forecasts for 2017, the S&P Energy sub-index is down almost 7% from the December peak. The Philadelphia Oil Service Sector Index is down more than 7% in the same period despite these supportive developments.
Multinational oil companies are starting to ramp their final investment decisions in the near term, which is also a good sign for oil services companies. Some of these projects are massive, and a number have low average capex of less than $8 per barrel of oil equivalent. Internal rates of return can range from the mid-teens to more than 20%, and all at a price of $50 per barrel. It certainly appears the industry is willing to spend again, particularly as prices move upwards as inventories begin to fall.