Oil, back to balance?

Over the last three weeks oil markets have peaked. The Brent oil price has gained 30% and is currently trading at USD 40.50/ bbl.

There are three reasons for this rally: rumours of a possible agreement between oil producers to control output, signals that non-OPEC production is falling, and the weakness of the US dollar.

In late February the market learned that Saudi Arabia and other big oil producers were discussing a possible supply freeze. The Saudi decision has given a strong signal that OPEC would like to change its oil policy of keeping high production in order to maintain oil prices under pressure. Recently Ecuador also hosted a meeting with other LatAm producers to reach a consensus over oil supply, and above all prices.

OPEC countries are suffering from an oil price collapse that is eroding their international reserves and their public finances, and destabilising domestic political and social balances in countries like Venezuela, Ecuador, Nigeria and Algeria. On average, the fiscal break-even cost for Saudi Arabia is USD 105/bbl and more than USD 70/bbl for the group of OPEC countries.

However, significant uncertainties remain about the composition of OPEC and non-OPEC participants in future decision-making and whether these participants will conclude a significant deal before early April. Recently, Iran put off plans to join the meeting and confirmed its goal to increase its production to 4 MMbbl/d.
The market momentum has been reinforced by new IEA data that confirms the decline in world production growth. Thus, in February global oil supply eased by 180 Mbbl/d to 96.5 MMbbl/d on lower production from both OPEC and non-OPEC producers.

Non-OPEC supply dropped by 90 Mbbl/d in February and should be down by 750 Mbbl/d in 2016 thanks to lower production in the US, Colombia, Mexico and China. Last month, US supply fell to 9.1 MMbbl/d, 0.6 MMbbl/d below the April 2015 peak, which was a consequence of a production decline in the Lower 48 onshore business (the number of oil rigs in activity continues to fall, currently being at 386, -55% y/y).

OPEC supply also eased back last month, by 90 Mbbl/d to 32.61 MMbbl/d, which was a consequence of losses from Nigeria and Iraq. Those losses were partly offset by increased flows from Iran. Saudi production remained steady at 10.23 MMbbl/d, while Iran increased its production by 220 Mbbl/d y/y to 3.22 MMbbl/d, its goal being 4 MMbbl/d.

Finally, while the global demand forecast for 2016 remains practically unchanged at 95.8 MMbbl/d, preliminary data suggests that OECD commercial inventories fell in February for the first time in a year. In our view, the oil price needs to remain below USD 40/bbl during two quarters in order to balance the market. We are maintaining our previous six-month price forecast of USD 40/bbl.

Erasmo Rodriguez – Senior Equity Analyst, Energy and Utilities – Union Bancaire Privée (UBP)