OPEC's Moving Target

Fact

• Brent crude almost touched $66 per barrel on December 12, then settled closer to $64 per barrel on profit-taking, but is still hovering at price levels not seen for two and half years.
• Markets are still digesting the results of the 173rd Ordinary OPEC Meeting, which two weeks ago saw the OPEC/non-OPEC group agree to extend production cuts for an additional nine months, to run through the end of 2018, with an option to review in June.
• Saudi oil minister Khalid Al-Falih noted in his opening address in Vienna that “we have only recently passed the halfway mark on the journey towards… reducing OECD petroleum stocks to the moving five-year average.” Al-Falih added that “a lot more needs to be done.”
• While inventories have been drawn into the high end of the range (see figure below), stocks could rise in the first half of 2018 driven by the traditional start of refinery turnarounds and seasonal factors.
• However, news that 450 thousand barrels per day (kb/d) of North Sea production has been taken offline due to a shutdown of the Forties pipeline for unscheduled repairs has buoyed markets. A possible three-week outage could draw global stocks by almost 10 million barrels.

Opinion

The five-year running average of commercial oil inventories is a moving target that is trending up, with lower-inventory years of 2011-2014 being replaced by higher-inventory years in 2015-2017. This makes it easier for OPEC to hit the inventory target as time passes - although we suspect that the real target is a price level that balances budgets without encouraging too much U.S. shale production - and not necessarily a specific inventory level.

The recent strength in Brent crude prices, in our view, goes beyond the Vienna agreement and the Forties interruption. Demand continues to be robust, supported by the underlying trend in economic activity, as well as seasonal growth due to cold weather. Furthermore, supply continues to be affected by geopolitical problems in Venezuela, Iraq, Libya, Nigeria, and other hot-spots around the globe.

OPEC’s five-year moving average target for oil inventories may be overstating the need for supply cuts. For example, while U.S. production has increased, takeaway infrastructure and changing refinery feeds have necessitated the construction of additional storage along the entire U.S. supply chain. See the CSIS commentary, “Bulls and Bears Converge,” from June 29, 2017.