The OPEC+ group has decided to increase output by aiming to return compliance back to 100 percent, rather than the “over compliance” the group has posted to date. Although it remains to be seen how that translates into tangible production increases, because the number most kicked around was about 600,000 bpd, which is a rough figure that the markets will be assuming.
The decision will still leave the oil market rather tight on supply, and could require further action in the not-so-distant future.
Still, there are several reasons why OPEC+ feels compelled to increase production. First, the oil market is already in a supply deficit, and in fact, it may have been experiencing a deficit for four straight quarters, according to Bank of America Merrill Lynch. In 2017, the supply gap averaged 340,000 bpd, evidence that the original OPEC+ agreement succeeded in draining inventories last year.
The inventory drawdown led to total stocks dropping below the five-year average, a development that likely occurred several months ago, although data is published on a lag.
A second reason OPEC+ needed to increase supply is because demand continues to grow at a strong pace. The IEA pegs demand growth at 1.4 million barrels per day (mb/d) this year compared to 2017; more bullish analysts like Goldman Sachs estimated demand growth at 1.7 mb/d. The forecasts may vary, but either way, demand looks robust, which would likely exacerbate the supply gap as the year wears on.
On top of that, demand rises seasonally in the summer months. According to Rystad Energy, demand could jump by 1.1 mb/d in the third quarter from the second quarter. Read that again. That is 1.1 mb/d quarter-on-quarter growth, not compared to 2017 levels. Of course, that seasonal demand will ease after the summer, but the strain on the market cannot be ignored.
Third, the supply disruptions are multiplying, and each individual flashpoint puts a significant chunk of oil at risk. Venezuela has already lost at least 500,000 bpd since late 2017, but events are fast-moving right now and the current shut-ins that are reportedly underway, due to a crisis at Venezuela’s ports, might mean that the losses are accelerating, although real-time data is hard to come by.
Reuters estimates that PDVSA’s oil exports fell by 32 percent in the first half of June compared to the same period in May. PDVSA was only exporting 765,000 bpd in the first few weeks of June, a decline of 368,000 bpd. If these numbers hold up, around half of the forthcoming OPEC+ increases will be offset just be Venezuela’s losses in June. In this context, there seems to be way too much media focus on the specifics of the OPEC+ increases, when the declines in Venezuela alone could cancel out a great deal of what OPEC+ is trying to achieve.
Meanwhile, out of nowhere, Libya lost 450,000 bpd in June because of attacks on the country’s two largest export terminals. Those outages look to be temporary, but the recent history of the North African country suggests that future outages are entirely possible.
Nigeria is also expected to lose a few hundred thousand barrels per day of oil exports in July because of pipeline outages.
Then there is Iran, which could lose somewhere between 500,000 bpd and 1 mb/d because of U.S. sanctions.
In a worst-case scenario where all four of these countries suffer sustained disruptions, all at the same time, OPEC+ would be hard pressed to plug the gap.
A fourth reason why more OPEC+ production is needed is because it looks increasingly likely that U.S. shale will undershoot production estimates over the next year. The pipeline problems have been known for some time now, but the bottlenecks are finally starting to bite. The Midland discount is expected to widen, and companies are going to have to continue to defer well completions. Ultimately, production growth will have to slow down.
With all of those factors in mind, the decision by OPEC+ not to take much more dramatic action is actually quite bullish. The market thought so as well – oil prices jumped on Friday once it became clear there wasn’t going to be a 1.5 mb/d increase that Russia had originally wanted.