By Euan Mearns
It is that time of year again where we try to forecast what the oil price will do over the coming 12 months. Last year I forecast $60/bbl for Brent year ending 2017 and with Brent trading on $66.50 as I write I can conclude that I got lucky this year. My friend wagered on $78 and our bet this year was too close to call. My forecasting effort is based on trying to understand the supply, demand, storage, price dynamic, and since this seemed to work pretty well this year, I will repeat the exercise with some slight modifications.
I have some reservations about the methodology stemming from 1) US LTO production has unpredictable impact on supply elasticity and 2) OPEC + Russia et al are withholding ~1.8 M bpd from the market. In effect this group will determine the oil price in 2018. If the price goes too high, they may open the taps a little to maintain the price they want, whatever that may be.
[The inset image shows “shale” fracking pads in the USA].
No one has ever been able to confidently forecast the oil price that is subject to a vast array of socioeconomic, geopolitical and technology variables. The best we can do is to assemble some of the key data and to try and use our experience to draw some inferences about what may happen. Readers act upon the information presented here at their own risk.
The oil market is now subject to production constraint amounting to ~1.7 Mbpd. This has led to rebalancing of supply and demand by the end of 2017. The Brent oil price has recovered strongly since the summer to close the year at around $66.50. Last year I forecast $60/bbl for December 2017 and therefore came close.
“The Cartel” of OPEC + Russia + others has seen a high level of compliance with cuts during 2017: 87% for OPEC and 81% for non-OPEC members. There is agreement to maintain the cuts through 2018, and I suspect a high level of compliance to continue until at least the summer. The Cartel will effectively decide what the oil price will be one year from now and that means striking a balance between balancing their own books, keeping the global economy buoyant and trying not to provide the frackers with too much incentive.
In 2017, Libya and Nigeria saw production rise by ~430,000 bpd, diluting the OPEC cuts significantly. This is likely a one-off production bonus that acted to suppress price in 2017. In 2018, this is unlikely to be repeated and this will underpin the current price rally.
Including the cuts, global oil production has been flat since the beginning of 2015. There has been deep retrenchment throughout much of the global oil industry and reduced investment must at some stage begin to show in production declines. Higher price today may well feed through to higher LTO and tar sands production next year, but there is little sign of that now. My supply forecast assumes average production in 2018 that is the same as the last two years. This assumption is seriously at odds with the IEA which sees non-OPEC production expanding by 1.44 Mbpd in 2018.
A static supply forecast sees substantial stock draw-down as the year progresses with the strong recovery in the oil price continuing into the summer. At this point, we may well see the OECD calling on The Cartel to release more supply.
This new higher price environment will see the frackers flocking back as the year unfolds, but there is little to no sign of that happening now.
There is so much geopolitical uncertainty in the world today it is impossible to factor in. For example, Russia and Saudi Arabia are leading partners in The Cartel while at the same time political enemies in Syria. War is on the cards in Korea, perhaps with a nuclear exchange. The OECD seems determined to phase out petrol and diesel cars as soon as possible. Meanwhile, Bitcoin mining threatens to consume all of the world’s electricity.
Putting it all together, I see a Brent oil price of at least $80/bbl one year from now.