Oil prices have started 2018 on a strong note. While the cold spell in the US and Asia and several upstream outages across December helped support sentiment, it is worth noting that less than 10 mb of production was lost due to the FPS outage and Libyan pipeline bombing, hardly a game changer by itself. Though previous outages have been far bigger (look back at the 2016 Canadian wildfires), the difference now is that the inventory overhang has largely been exhausted.
Today, the global inventory overhang is no more than 100 mb and likely closer to 70 mb. US crude stocks ended 2017 some 36 mb above the five-year average, but since 2014 at least 34 mb of crude has headed to pipes for linefill. So prices will be sensitive to geopolitical risks.
There are still plenty of sceptics who believe surging US production will thwart the price rally. While the significant upside surprise in October 2017’s production figures has also prompted us to raise our 2018 full-year US output forecast, and we expect US crude exports to average 1.5 mb/d, we believe demand growth is strong enough to absorb these volumes, much like H2 17.
Similarly, while OPEC and Russian compliance is likely to slip in H2 18, as long as this is in response to rising supply-demand imbalances, the downside to prices will be limited.
Prices will not rise in a straight line, however. The usual seasonal pullback in late Q1/early Q2 18 is still on the cards, especially as there is still a small buffer to run down before the market is truly tight. But there is good reason for oil to trade with an upside bias, as the current fundamental backdrop is, for the first time in years, robust enough to attract new investors into the space.
|Fig 1: Brent forward curve, $ per barrel||Fig 2: Brent and US bonds breakeven rates|
|Source: Datastream, Energy Aspects||Source: Bloomberg, Energy Aspects|