Energy Monitor October – US oil production declines

by: Hans van Cleef

131015-Energy-Monitor-Oct1.pdf (149 KB)
  • Oil prices rise due to drop in US production and possible increase in global oil demand
  • Oversupply will remain for the time being, and will keep prices relatively low
  • Forecast gas prices revised lower due to high inventories and mild weather conditions

Oil price finds support on better supply/demand balance

After several relatively calm weeks, oil prices started to gain. The main reasons are a drop in US crude production and an upward revision of the expected global demand for 2015 by the International Energy Agency (IEA). Also the increased geopolitical tensions surrounding the conflict in Syria provided support. The fact that Russia intervened in the conflict is an unexpected development in this crucial region for oil. Russian rockets do not always hit the targeted Syrian targets, but have also been dropped – by accident – on Iranian territory. Besides that, Russian troops also hit the anti-Assad rebels and have entered the Turkish airspace without permission. This has lead to increased tensions with a risk of further escalation of aggression in the region. This translates to a higher risk premium being priced in to the oil price. Finally, the negative sentiment surrounding Chinese economic growth diminished and the US dollar weakened somewhat. The last two drivers lead to less restrictions to a potential further upside to the oil price recovery.

Recently we changed our forecasts for Chinese economic growth from 7% to 6.5% in 2016 (click here for more information). We also delayed our call for a possible rate hike by the US Federal Reserve to June 2016. This means that EUR/USD is expected to keep trading between the EUR/USD 1.10 – 1.15 range (click here for more information).

The IEA revised its forecasts for global demand for oil in 2015. The IEA now expects a rise of 1.7 million barrels per day (mb/d) compared to one year ago. This would bring the total global demand for oil above 95 mb/d, which is a record high. The rise in demand is a clear result of the relatively low oil prices as well as ongoing economic growth.

The low oil price is also starting to have a visible effect on US oil production. After Non-OPEC (excluding US) oil production already declined earlier, also US oil production dropped more than 5% compared to the peak in June 2015 (Figure 2). The oil production peak was 9.6 mb/d and dropped to just over 9 mb/d at this moment. The main questions is whether this decline will continue – and therefore support the market by finding a better balance between supply and demand – , or whether it is just a temporary effect. As new investments in the sector are extremely low at this moment, a further decline of US oil production seems to be likely in the coming months.

The number of US oil rigs has been under pressure since Q4 2014. Although this is an important indicator, which confirms that low oil prices is leading to less investment in the sector, US oil production continued to increase. That is, until a few months ago. The continued rise was based on production of earlier drilled wells (back-log), as well as increased productivity per oil production well.

Higher oil price expected

The risks of a decline in investment in the oil sector seem to have increased. Although there is still a significant oversupply of oil in the market, this could switch into a deficit in the coming years. After all, oil demand will continue to increase – especially in emerging markets – while the production could fall under pressure during the coming years as a result of a lack of investments. If the market starts to anticipate a better balance between supply and demand, oil prices could already start to rise. This could be the case, even if there is still a situation of oversupply.

The current oversupply will remain for some time. Although we do see production cuts in the US, production within OPEC, but also for instance in Russia, continues to rise. And if sanctions against Iran are lifted, even more oil could be heading towards the market. This will keep oil prices lower compared to the average oil prices seen during the past few years.

To summarize, we see: higher demand for oil, a drop in US oil production, an increased risk premium based on geopolitical tensions in the Middle East, a market which anticipates finding a better balance between supply and demand, and the fact that further US dollar appreciation is no longer expected and therefore will not cap any upside potential for oil prices. Therefore, we maintain our forecast for a moderate rise in oil prices, keeping it significantly below the 2011-2014 averages. Please see Table 1 for more details on our Brent and WTI oil price forecasts.

Henry Hub Gas price expectation revised lower

We lowered our expectation for the Henry Hub gas price. Inventories proved much higher than normal during this time of the year. Furthermore, the market expectation for another mild winter is building. While the past two winters were already relatively mild in the US, expectations point towards an even warmer 2015/2016 winter in the US. It seems that there is a strong El-Niño building this year. Normally, this leads to mild winters in the Northern-Hemisphere, and therefore also in the US.

The Henry Hub gas price currently trades around USD 2.50/mmBtu. The likelihood for a fast price recovery has diminished. As a result, we lowered our expectation for the 2015 average Henry Hub gas price to USD 2.75/mmBtu from USD 3.00/mmBtu, similar to our year-end target.

Also the price of TTF gas seems to be lower than forecasted due to lower than expected demand, and high inventories for this time of the year. The revisions of our price forecasts are less extreme than is the case for Henry Hub though. Please see Table 1 for more details on our gas price forecasts.