An equity investment analyst in the energy sector for over 30 years, Paul Kuklinski founded Boston Energy Research in 1992 to provide independent research to large financial institutions. He was previously a partner at Cowen & Co. and a founding partner of Harvard Management Co. In this guest column, Kuklinski explains that for now at least due to excess production, global oil supply will exceed demand and thus will help keep fuel prices relatively stable through 2018. Yet the risk for higher prices increases thereafter. Contact Kuklinski at [email protected] for a more detailed discussion including the risks to his outlook.
Oil prices are likely to remain relatively stable into mid 2018 as surplus inventories remain high. The growth in Permian production and the recovery in Libya and Nigeria are preventing OPEC – the Organization of Petroleum Exporting Countries – from achieving the goal of its production cut.
The outlook changes thereafter. Without higher prices, world oil supply is then unlikely to keep up with continuing growth in global demand. Thus, for 2020 and beyond, the risk of an oil shortage is high.
Currently the West Texas Intermediate (WTI) price of oil – the commodity price for oil in the U.S., used on the New York Mercantile Exchange – is currently $50.50 per barrel. Without a geopolitical event, WTI is expected to remain near $53 per barrel well into 2018 before increasing in the second half of 2018 with a decline surplus inventories related to the seasonal ramp up in demand. It is expected to average $50 per barrel for all of 2017 compared with $43 per barrel in 2016.
The Brent price for oil – which serves as the major benchmark price for purchases of oil worldwide – is $56 per barrel, which is $5.80 above WTI, but down from a recent premium over $7.
Through August, the 2017 Brent premium over WTI averaged $2.01 per barrel but widened dramatically in the aftermath of seasonal maintenance in the North Sea, Hurricane Harvey, and the Kurdish vote for independence. Brent reached a two year closing high of $59.02 per barrel on September 25.
Geopolitical uncertainty added a risk premium to oil prices since the overwhelming in favor of independence in Kurdistan on September 25 including the partly Kurdish Kirkuk region of Iraq.
In response, Turkey threatened to choke off crude oil exports through Turkey which were 575 million barrels per day in September. The primary issue is control over the super-giant Kirkuk Field, which accounts for nearly half of exports through Turkey.
If implemented, the quarterly impact on world oil supply would be a reduction of 52 million barrels per day, which would accelerate the return to a market balance and likely result in higher oil prices in response.
Otherwise, excess global crude oil inventories are likely to remain high over the next 12 months. A 57 million barrel per day increase is even indicated for the first half of 2018 with the seasonal decline in demand, posing a temporary downside risk to oil prices as it occurs.
For example, when it announced its production cut in the fourth quarter of last year, OPEC believed elimination of the surplus in Organization for Economic Cooperation and Development (OECD) nations – a forum where the governments of 34 democracies with market economies work with each other – would cut inventories and increase oil prices to between $60 and $65 per barrel. The group of OECD nations, by the way, accounts for 48% of total world oil demand.
By August, though, that surplus was still 170 million barrels per day larger, but down from 318 million barrels per day surplus earlier in the year.
Still, the outlook for world oil demand continues to increase, supported by strong global economic growth, particularly among OECD nations. In its latest estimate, the International Energy Agency (IEA) expects an increase of 1.6 million barrels per day this year and another 1.4 million barrels per day increase in 2018. As a result, by the fourth quarter of 2018, global oil demand is expected to reach 100 million barrels per day.
That’s one reason why a potential oil shortage looms in 2019-2020. Last year, new discoveries added less than five billion barrels to global reserves, versus produced volumes over 30 billion barrels. The spend on the global oil production base outside the Middle East, Russia, and U.S. land, will be down 50% this year from 2014 and though U.S. shale oil production is growing, it is only 8% of world oil supply.