IEA’s Shocking Revelation About U.S. Shale

By Nick Cunningham 

The oil market is exhibiting signs of having reached a “new normal,” according to the IEA, with the floor for oil prices jumping from $50 to $60 per barrel. But a few factors could poke holes in that price floor, and market watchers should be careful not to become overly optimistic about the trajectory for oil prices, the agency says.

In its latest Oil Market Report, the Paris-based energy agency says that a confluence of events have pushed up Brent prices. Lower-than-expected oil production figures coming out of Mexico, the U.S. and the North Sea have combined with unexpected outages in Iraq (-170,000 bpd in October), Algeria, Nigeria and Venezuela. Those outages, plus the geopolitical turmoil in Iraq, and especially Saudi Arabia, have heightened tension in the oil market.

Inventories also continue to decline. OECD commercial stocks fell below the symbolic 3-billion-barrel mark in September for the first time in two years.

That seems to have put a floor beneath Brent crude prices at $60 per barrel, creating a “new normal” after prices had bounced around in the $50s for months. But the IEA cautions that the floor is not a solid one, and that a “fresh look at the fundamentals confirms…that the market balance in 2018 does not look as tight as some would like.”

For one, some of those outages are temporary. North Sea and Mexican production recovered from maintenance, Iraq is scrambling to restore output (and raised exports from its southern fields to compensate for outages in the north), and shut-ins related to Hurricane Harvey in the U.S. have largely been restored. Libya and Nigeria saw their output inch up in October.

But the real news is that the IEA downgraded its demand forecast for both this year and next. The agency lowered its 2017 forecast by 50,000 bpd, which may not seem like much, but is the result of a more recent slowdown – the agency says that demand in the fourth quarter will likely end up being 311,000 bpd lower than it previously thought. There are a variety of reasons for this, including fewer heating degree day numbers for the winter, lower demand in the Middle East (Iraq and Egypt), and some “modest changes elsewhere.”

On top of that, oil prices have jumped 20 percent over the past two months, putting a dent in demand. The IEA assumes a price elasticity of oil demand at -0.04, which means that every 10 percent increase in prices implies a 400,000-bpd decline in oil demand (given that total demand is at nearly 100 mb/d).

Overall, the IEA revised down its 2018 oil demand forecast by 190,000 bpd.

The deceleration in demand will leave the market with a surplus in the fourth quarter, and that slowdown will continue into 2018. Global supply will exceed demand by a rather substantial 0.6 mb/d in the first quarter of next year, and the surplus will linger in the second quarter, narrowing to 0.2 mb/d.

That comes after a lot of progress was made this year in lowering inventories. The supply surplus suggests that inventories will resume their climb for the next few months, perhaps through mid-2018.

The sudden pessimistic outlook for the oil market is a symptom of explosive growth from U.S. shale, which, combined with other non-OPEC producers, will result in an additional 1.4 mb/d in fresh supply in 2018. That is a staggering number, and so large that “next year’s demand growth will struggle to match this,” the IEA said. The agency warned that “absent any geopolitical premium, we may not have seen a ‘new normal’ for oil prices.”

In a separate report – the IEA’s annual World Energy Outlook – the agency dismissed predictions about peak oil demand, arguing that any increase in EVs will be more than offset in robust demand growth from other sectors, including trucks, aviation, maritime transport and petrochemicals.

Moreover, the U.S. will apparently be the one that meets that growth in demand. The IEA said that the U.S. shale revolution will mean that combined oil and natural gas will have to rise to “a level 50% higher than any other country has ever managed.” The IEA says that the 8 mb/d increase in tight oil production between 2010 and 2025 “would match the highest sustained period of oil output growth by a single country in the history of the oil markets.”

In other words, the shale revolution still has a long way to go, and when all is said and done, the U.S. will have added more supply in a shorter period of time than even Saudi Arabia did at its peak.

Taken together, the two reports from the IEA may have just burst the oil price bubble – prices plunged on Tuesday, erasing a large chunk of the gains seen in recent weeks.

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