Energy Monitor April – Record stocks help cap oil production

by: Hans van Cleef

  • Oil stocks hit record levels, but this will not impede oil price recovery
  • Falling overproduction supports further oil price recovery
  • Gas price forecasts revised down on moderate demand and abundant supply

 

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Stocks at record levels, but how bad is that?

High oil production is driving up stocks to record levels. The weekly stocks data published in the US almost invariably show that stocks have grown stronger than expected. Many market parties believe that these high stocks will prevent oil prices from rising. Their reasoning is that even if production falls, stocks would still be ample to meet demand. But how large are these stocks in actual fact, and how does this fit our scenario of rising oil prices?

According to data of the US Energy Information Administration (EIA) Agency, the OECD commercial stocks of crude oil are now some 15% higher than average (Figure 1). The EIA expects this upward trend to continue from 66 days of stocks now to more than 70 days of stocks in 2017. With total demand from OECD countries for oil running at some 46 million barrels per day, this would entail that the OECD’s stocks currently comprise over 350 million barrels of oil. These include the US stocks. In Cushing, Oklahoma, stocks have risen even faster. In 2013 and 2014 the stocks in Cushing decreased significantly. Since the start-up of the TransCanada Cushing Marketlink pipeline, the stocks from Cushing can be transported towards the US Gulf Coast (USGC). And the subsequent expansion of the infrastructure has even made it possible to transport the crude oil directly to refineries on the east and west coasts and the USGC without going through Cushing. Due to the sustained high production, however, storage levels at Cushing have risen sharply again as can be seen in Figure 2.
Many voices in the market claim that the arrangement between several OPEC and non-OPEC countries will have no material impact on global production, partly because stocks are at record levels. We take a different view. These record stocks will actually help production to stabilise, or even decline. In the first place, production is being hit by the low oil price. In various non-OPEC countries, including the US, we already see production decelerating. Though some may have thought, and hoped, that production would come under pressure faster, a break in the trend is now clearly visible. Even so, there is still an oversupply. Because stocks are at record levels and, above all, because storage capacity is running low, producers must decide between maintaining production and selling at rock-bottom prices (an untenable situation) or stabilising or even reducing output (and thus contributing to the agreement to freeze production and support the price).

We think that commercial considerations will prompt US oil producers to rein in output and thus restore equilibrium to the market. The record stocks thus need not impede a slight oil price increase. Due to the lack of investments in the oil sector, supply is certain to come under pressure in the coming months and years. The biggest risk is that underinvestment might affect production growth to such an extent that the current level of supply cannot be guaranteed. If the demand for oil continues to rise in the coming few years (average of the past years is an annual increase of 1.5 million barrels per day), then there will no longer be overproduction and possibly even a shortage of oil within 18-24 months. The current extra eight days of OECD stocks will then melt away like snow in the sun. If the market continues to anticipate a further decline in the oversupply, this will lead to upward price pressure. We also no longer see the US dollar being a potential drag on the oil price recovery. We do think that the high stocks will serve to limit the oil price increase that we expect to an average level of USD 50/barrel in 2016 and USD 60/barrel in 2017 (Table 1).

Gas prices simmering on a low burner

After yet another mild winter, gas prices are at a very low level now that stocks are high for the time of the year and demand is not expected to pick up in the coming months. Alongside the moderate demand for gas for heating, the demand for gas for electricity generation is also under pressure. More and more renewable energy is available and the price of coal is extremely low. Though coal generates more carbon dioxide than gas, it is economically more attractive to use coal as the prices of carbon emission rights are also at their lowest level since mid-2014 (Figure 3). For this reason, Dutch carbon emissions increased in 2015 despite the rising share of renewable energy.

The Dutch government has imposed significant constraints on the production of the Groningen gas field, but this has had little impact on the global supply of gas. The global supply was not extremely relevant anyway, because gas is predominantly transmitted through pipelines, which means you always deal with fixed suppliers. As long as gas imports fit within the conversion capacity (mixing in nitrogen for use in the Netherlands), the Netherlands, and its customers, will become increasingly dependent on gas producers such as Norway and Russia. However, the construction of LNG terminals has provided a new alternative.

Gas prices remain low, outlook revised down

Now that the price of LNG has fallen sharply due to lower demand from Asia and accelerating supply, LNG has also become more competitive in price terms. This will continue to exert pressure on the price of gas in the Netherlands (Title Transfer Facility – TTF) and the United Kingdom (National Balancing Point – NBP) (Figure 4). The linkage of the gas price with the oil price is continuing to weaken, with the US taking the lead and notably Europe following suit. However, this link can still be seen in other parts of the world, particularly for futures prices. As the effect of the recent oil price increase is not yet visible, and we expect the oil price to rise further, we also foresee some upward price pressure for gas. Nevertheless, due to the strong supply and subdued demand, this upward potential will be significantly less than indicated in our earlier forecasts. See Table 1 for our new forecasts.