OPEC’s oil production continues to decline, hitting a one-year low in April.
Compliance with the OPEC/non-OPEC deal hit yet another record high because of a 70,000-bpd dip in April, putting collective production levels at 32.12 million barrels per day (mb/d). The losses are largely the result of ongoing declines in Venezuela, plus deteriorating production from aging oil fields in Angola. The strong cohesion among OPEC’s other members helped push the group’s compliance rate in April jumped to 162 percent, according to a Reuters survey, up slightly from March.
The production losses in Venezuela are not a surprise. Output has plunged below 1.5 mb/d, down 600,000 bpd since 2016. The country is in crisis and the recent crackdown on Chevron employees in the country presages more production declines, particularly if the remaining private companies start to cut back on their personnel and spending.
But another source of production declines has gone largely unnoticed in western media. Angola is producing 260,000 bpd less than its OPEC production target, according to Reuters. Its oil fields are suffering from natural declines, a problem that will be difficult to reverse. Angola’s offshore oil fields are costly to maintain, and there is little sign that the necessary investment is forthcoming.
Overall, OPEC collectively produced 610,000 bpd less than its stated target in April. That is significant gap. Because most oil market forecasts assumed OPEC would adhere closely to the production targets, and not under produce, most analysts predicted at the start of 2018 that the oil market would see inventory builds again in the second quarter. The severe production losses in Venezuela and Angola, combined with strong demand, suggests that won’t be the case.
The strong compliance rate is rapidly tightening the oil market. Global inventories are likely close to their five-year average, although because data is published with two-month lag, it is hard to tell in real time. That raises the possibility that the cuts will overtighten the oil market, as OPEC is essentially looking through a rear-view mirror when it assesses the status of supply and demand. And things will only get tighter as the year wears on.
The narrative surrounding explosive U.S. shale growth largely centered on when and by how much shale drillers would flood the market. Aggressive oil market forecasts predicted that U.S. shale would grow so fast that it would not only offset OPEC cuts, but it could bring back a supply surplus, pushing oil prices back down.
But sentiment has notably changed in the past few weeks. Now, a growing number of analysts see U.S. shale growth as necessary to prevent a supply shortage and subsequent price spike. “[H]higher US oil production is needed to plug the supply gap,” Commerzbank wrote in a note on Monday.
One key bullish wildcard for oil is the potential for U.S. shale to underperform. Concerns have grown about the possible bottlenecks in the Permian, which could slow growth. To be sure, it is still a little too early to tell if shale drilling will bump up against some production constraints. Weekly EIA surveys continue to show rapid growth. However, steep discounts for oil in Midland, TX suggest that the pipeline bottlenecks are real. It could be a few months before the full extent of the problem becomes visible, but if U.S. shale growth slows sooner and by a larger magnitude than most forecasts assume, oil prices will almost certainly move higher.
Still, in the short run, all eyes will be on the Trump administration as it mulls the fate of the Iran nuclear deal.
“The increased drilling activity in the US should not pose any excessive obstacle to oil prices, in other words, especially as there are no signs of any solution to the dispute over the nuclear deal with Iran,” Commerzbank said in a note.
The oil market is on the verge of overtightening even before we consider Iran. When adding in potential production losses from the Islamic Republic, which could hypothetically reach 500,000 bpd within the first year after sanctions are re-imposed, the potential for a price spike grows significantly. Israeli Prime Minister said on Monday that he had evidence that Iran is cheating on the nuclear deal. Whether or not the evidence has merit, the announcement will have the effect of ratcheting up tensions between Iran and the U.S. ahead of a key decision by the Trump administration to withdraw from the nuclear accord.
The list of bullish factors for oil continues to grow, while the bearish side of the ledger looks thinner by the day.