Fundamentals is our monthly review of global oil data, this is the December edition. Happy holidays, we'll see you in 2019!
There have been several changes to our balances since last month, most notably due to the OPEC+ agreement and the Alberta provincial government decision to cut production in order to erase the inventory overhang. We have also reduced our demand growth figures due to the lack of clarity over the US-China trade dispute (despite the 90-day truce), which has led to weakened demand, severe destocking among Chinese end-users, and has been filtering down to regional economies that export heavily to China. We now see y/y demand growth of 1 mb/d, versus 1.3 mb/d previously, with all the downgrades coming from China, US, Europe, Korea and Japan. Separately, the European outlook has deteriorated sharply amid political uncertainties surrounding Brexit, as well as protests in France and budget wrangling in Italy.
In terms of the OPEC+ deal, OPEC crude output should fall by around 1 mb/d q/q to 31.6 mb/d in Q1 19 and stay at those levels in Q2 19, mainly due to the core Middle Eastern members reducing production. We assume Saudi Arabian output of 10.3 mb/d in Q1 19, rising to 10.4 mb/d in Q2 19, while the UAE and Kuwait will hold production at 3.1 mb/d and 2.7 mb/d respectively through H1 19. FSU output should fall by 0.1 mb/d q/q to 14.6 mb/d in Q1 19 and then again to 14.5 mb/d in Q2 19, led entirely by Russia. We do not believe Kazakhstan will comply. Azerbaijan’s 2% decline will effectively be natural declines, which are largely captured in our balances. Along with cuts in Canadian output, this will clear up the supply overhang that was expected in H1 19, pushing balances to a small draw of 0.10 mb/d (with small builds in Q1 19 more than offset by draws in Q2 19).
While we assume that OPEC members will comply with the new quotas in H1 19, we factor in a gradual increase in production from both OPEC and Russia in H2 19, whether the deal is extended or not, as they will adjust their stance based on the evolving market fundamentals—the strength of demand and the size of Iranian losses—much like they did in 2018. As a result, our balances for H2 19 will depend on these variables, which could push Saudi Arabia and the other core OPEC members to boost production even beyond our current assumptions, if required. For now, we assume that OPEC production will rise to 32 mb/d in Q3 19 and 32.1 mb/d in Q4 19, with Saudi output averaging 10.7 mb/d, the UAE at 3.3 mb/d and Kuwait at 2.8 mb/d. Between them, that would leave spare capacity at around 0.5-0.6 mb/d, leaving enough room to raise output further should the need arise. Given our revised outlook for demand growth, we do not expect the GCC will need to raise output beyond what we have already factored in, which would leave the market with stockdraws of 0.3 mb/d in Q3 19 before builds return in Q4 19 (0.2 mb/d) as US production starts to surge following the build-out of Permian pipelines.
In terms of crude only balances, high refinery maintenance will largely offset OPEC cuts through April, keeping crude stocks flat before steep stockdraws resume in late Q2 19 and then small builds return in Q4 19 as US production growth picks up following the debottlenecking of the Permian. In terms of light-heavy balances, much will depend on how much of the OPEC+ cut is biased towards lights. Saudi Arabia’s decision to cut output to west of suez refiners implies the cuts will have to be focused on medium sours as that is the baseload crude that comes to the west. So even if the others reduce more light crude output proportionally, total light cuts may not be over 50%.
Still, this means a very tight sour crude market, especially once the three Asian refineries Hengli, Rongsheng and Rapid ramp up, which should be by late Q2 19/early Q3 19. But this also means that East of Suez sours can come under pressure in Q1 19 as OPEC continues to supply Asian refiners at a time when refinery maintenance is high, but new sour crude demand will only appear once Hengli and Rongsheng have used up the crude they have already purchased and raise their run rates. Instead, cuts to the West of Suez imply Mars and Urals should strengthen, possibly leading to a narrowing of Mars-Dubai/Oman and Urals-Dubai/Oman spreads to close off the arb to the east.