We published an article, What Is Keeping The Oil Prices Low? in February that highlighted the reasons behind the current downturn in crude oil prices and its impact. The following is an update on that material.
The June WTI is trading close to $48.35, while the July Brent is at $49.11, implying an improvement by about 49% from our last post. At any point in time, there is a complex dynamics behind crude oil trends that combines the impact of long and short-term factors. Read How is Oil Price Really Determined?
The Supply Side
OPEC has released its May 2016 report and has predicted non-OPEC oil production to come down by 0.74 million barrels per day (mb/d) this year. The OPEC think-tank is exploiting its dominant market position and financial bandwidth to wait out its rivals.
Accordingly, it has given no indication of any production cuts and the results are evident. The biggest impact of the low price regime is expected to reflect in the U.S. With profits under severe pressure, the supply is likely to contract by 0.43 mb/d in 2016. As many as 69 U.S. shale oil companies have already filed for bankruptcy in the current year alone. China, Mexico, UK, Kazakhstan and Colombia are also expected to reduce production in 2016. On the other hand, Canada, Brazil, Russia and Malaysia might increase their output. In addition, Iran has ramped up its production faster than anyone thought. Nevertheless, the oversupply is believed to be shrinking and these cyclical headwinds are supporting the current prices.
The Demand Side
On the economic front, OECD GDP growth is likely to plateau at less than 2%, same as last year. Therefore, its demand in 2016 is projected almost same as the previous year. Substitute energy sources have been reducing Japan's dependence on crude oil and the downward movement in its demand is expected to continue. News from Brazil and Russia is also not positive as they are in the recession zone. India and China, however, show some silver lining with better than expected reported growth. Latin America is softening, while rest of the Asia and Middle East are showing promise. The overall current year demand is expected to be about 31.5 mb/d up from 29.7 mb/d in 2015.
What does GDP mean?
Some temporary factors are also in effect, such as the wildfire in Canada that has disrupted the supply for a couple of months. Elsewhere, internal political disturbance in Libya has led to a blockage and an embargo, which is suppressing some part of the supply. The two sides at either end of the conflict seem to be coming around and the remaining supply is also likely to be restored. In addition, Libya is not a major producer with only approx 1.5 mb/d supply and therefore, is not going to be a significant factor in the global supply.
Terrorism in Nigeria poses significant uncertainty, mainly because the country accounts for almost 6.3% of OPEC production that translates to about 3.5 mb/d. The Delta region attacks have crippled the supply by as much as 40%. Against the budget estimate of 2.2 mb/d, the current supply is only 1.4 mb/d. Nigeria is in a tough spot as nearly 70% of its national income depends upon crude exports and it has one of the highest break-even points among the OPEC members.
Venezuela is another important player, contributing to about 7.8% of OPEC production. The country's economic turmoil doesn't seem to be letting up and is impacting the oil production. The disruption is more deeply rooted and is likely to hinder its long-term production capability. Similar to Nigeria, Venezuela also depends largely upon oil exports, where weaker global prices do emancipate its production.
Market watchers expect crude prices to remain in the proximity of $45-50 for the rest of the year. However, this will hardly be enough for most producers, since they need much higher levels to break-even.
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