February was a volatile month for oil prices, with daily swings of more than 7 percent witnessed on four occasions. By the end of the month, the international crude benchmark, Brent, recorded its first month-on-month gain since October, rising by 3.5 percent to $35.9 per barrel ($/bbl). The US marker, West Texas Intermediate (WTI), closed the month roughly level with where it ended in January, at $33.7/bbl.
Amid overwhelmingly bearish market sentiment related to a crude supply glut that has so far shown little sign of unwinding, oil prices received support from the recent entente between non-OPEC Russia and Saudi Arabia over capping oil production. The two oil producers, which together account for 22 percent of global crude supply, agreed to freeze output at January’s levels provided other OPEC members such as Iran and Iraq follow suit. Despite welcoming the Saudi-Russian move, neither Iran nor Iraq is likely to commit to any agreement, least of all Iran, which is emerging from three and a half years of sanctions and is desperate to recapture the market share it lost to rivals during that period.
Furthermore, towards the end of the month, oil prices, especially Brent, were boosted by news that crude supplies from northern Iraq and Nigeria had been curtailed as a result of a pipeline stoppage and leak, respectively. The loss of approximately 600,000 barrels per day (b/d) of crude from Iraqi Kurdistan and 250,000 b/d of Forcados grade crude from Nigeria, pushed Brent up to an eight-week high of $37/bbl on Feb 26. Once again, this demonstrates the ever-present risk of supply disruptions in geopolitical hotspots such as the Middle East and Africa.
Indeed, many, including the International Energy Agency (IEA), are growing increasingly concerned about the prospect of future supply outages having an outsized impact on oil markets. With upstream oil investment being pared back by 24 percent as oil majors adjust to the new era of lower prices and OPEC spare production capacity at a historically low level (equivalent to 2.5 percent of global oil supply), there is little spare supply to compensate for any potential loss of output. This would set markets up for a period of greater price volatility and higher price spikes.
For the time being, however, oil markets are saturated and prices are depressed. Iran’s reentry to international markets in January following the lifting of sanctions, coupled with sustained commercial crude stock builds and the resilience, albeit weakening, of US shale production, continue to weigh heavily on sentiment.
Oil markets expected to rebalance in 2017 but sizeable stock levels will slow the pace of recovery in oil prices.
According to the IEA, the supply overhang that has characterized oil markets since 2014 is not expected to fully unwind until 2017/2018 at the earliest. Even then, oil prices are not likely to recover significantly before the enormous stocks of crude and refined products that have accumulated over the last few years begin to draw down.
In its recently released Medium-Term Oil Market Report 2016, the IEA estimates that supply, having exceeded demand by 0.9 mb/d in 2014 and by 2 mb/d in 2015, will see the gap narrow to 1.2 mb/d this year before roughly balancing demand in 2017.
Demand is forecast to rise by 1.2 mb/d this year and to continue growing by an annual average of 1.3 mb/d over the medium term to 2021. Supply growth is set to slow considerably, from a high of 2.8 mb/d in 2015 to 0.4 mb/d this year, led by a 0.6 mb/d decline in non-OPEC supply, especially US shale oil. From 2018 onwards, however, as oil prices recover to levels that make oil production more profitable, non-OPEC supply growth is expected to rebound to average 0.7 mb/d.
January saw OPEC crude output increase by 132,000 b/d to 32.3 mb/d, according to OPEC secondary source data. Excluding the 700,000 b/d contributed by Indonesia, which rejoined the group last December, aggregate OPEC output stood more than 1.5 mb/d higher than a year ago. Once again, Iraq and Saudi Arabia posted the largest gains among the group’s Arab oil producers, supplying an additional 60,000 b/d and 44,000 b/d, respectively. Kuwait recorded a small increase of 17,000 b/d in January. Nigeria’s increase of 74,000 b/d was the largest among OPEC members in January.
Iran, for its part, boosted output by 38,000 b/d to 2.9 mb/d in January after sanctions were lifted. Iranian production should top the psychologically important 3.0 mb/d level sometime over the next two months; the last time the Islamic Republic pumped at this level was in May 2012, just before international sanctions were applied.
Iran also managed to export its first post-sanctions shipment of crude, of around 4 million barrels, to several European customers, including France’s Total. The deal with Total, which is reported to involve the purchase of 160,000 b/d of Iranian crude, comes in the wake of a visit to Europe by a delegation of Iranian business officials headed by President Rouhani earlier in the month. Iran has had to offer steeper discounts on its crude than it had originally envisaged in order to successfully compete with the likes of Saudi Arabia and Iraq in an oversupplied market.
Looking ahead to the rest of 2016 and beyond, Iran and, to a lesser extent, Iraq are likely to be the largest sources of OPEC supply growth. The IEA considers a 1 mb/d increase in Iranian production capacity to 3.9 mb/d to be a realistic medium-term target for the country. The Iranian authorities, in contrast, have set themselves a goal of 5 mb/d by 2020. Output increases of that magnitude (73 percent), however, would not be possible without considerable investment and access to new technology. In view of Iran’s uncertain domestic politics, the current environment of low oil prices and increased cost-cutting by oil companies, that seems overly ambitious.