EUR 3.48 For Business Accounts Only

Nigeria Strategy Report H1 2018 Excerpts - Crude Oil: Sunny with a chance of Rain

• Crude oil market entered the second half of 2017 with the sun on its cheek. Disruption in production in the US, due to hurricane impact, as well as higher compliance by OPEC and its allies fast-tracked the rebalancing. While our expectation for demand picture was in sync with actual, the supply picture exceeded our expectation due to higher compliance by OPEC and non-OPEC to the production cut agreement as well as the hurricane impact on US production. Consequently, crude oil market switched to a deficit of ~200kbpd in the review period. The impact of this led to a positive momentum for crude oil prices, rising ~36% over H2 2017 (peak of $65/bbl.) with average Brent at $56.4/bbl. running slightly ahead of our forecast ($55/bbl.).
• At its November 2017 meeting, OPEC and participating non-OPEC producing countries agreed to extend its production agreement (the Declaration of Cooperation) for the whole of 2018, an additional nine-months on top of the previous agreement. Furthermore, the cartel and its allies have agreed to convene in June 2018 to review its action based on prevailing market conditions and the progress achieved towards re-balancing of the oil market. More importantly, Nigeria and Libya have now been included in the agreement. Pertinently, Saudi Arabia and Russia, the key players, reinforced their alliance to comply with the agreement, as crude oil stability is in the best interest of both countries. Consequently, 2017 average compliance for OPEC and participating non-OPEC members prints at 87% and 80% accordingly.
• Going into 2018, the ability of OPEC and its allies to stick with its commitment will be one of the key factors for the direction of the crude oil market over the course of the year. Stronger cooperation and aligned interest by OPEC and participating non-OPEC producers, as well as inclusion of Nigeria and Libya to the agreement, and subsisting challenges facing Venezuela guides to strong compliance over 2018. Consequently, we estimate compliance rate of 95% and 85% for OPEC and non-OPEC respectively.
• Elsewhere, our views on US production is largely hinged on hedging activity, investment spending, technological advancement even as dissipating hurricane impact suggest a pick-up in stifled production. The same dynamic is playing out in other countries as well, such as Brazil and Canada, which account for the majority of the remainder of the supply increase. Elsewhere, over the nine-months of 2017, US drillers increased capital expenditure (CAPEX) by over 20% on the back of higher crude oil prices, lower break-even price as well as recent tax reforms which is positive for drillers . Thus, with oil above $60/bbl., there is a tremendous incentive for shale producers to drill more in 2018. Consequently, we expect US production to average 9.8mbpd in 2018 (+600kbpd from 2017 average of 9.2mbpd) with possibility of crossing 10mbpd in Q4 2018. On balance, with the US increasing production, the market will rely on high compliance by OPEC and its allies to keep the market tight. Based on our expectation of similar compliance level as with 2017, US increase in production equates to ~70% of production cut by OPEC and its allies. Consequently, we still expect a decline in global supply which we forecast at 99.6mbpd (+700kbpd YoY).
• On the demand side, growth is expected to come largely from the non-OECD region, particularly China and India, as structural changes and restrained growth in the OECD region (particularly Europe) will keep demand subdued. Overall, we forecast an increase of 1.4mbpd in global oil demand to 100.5mbpd over 2018, albeit a slower momentum from 2017 growth.
• On balance, we expect the market to remain in a deficit over 2018 at about ~400kbpd largely reflecting strong oil demand, falling stocks, and production restraint among OPEC and non-OPEC producers. Also, growing geopolitical risks are likely to prop up the market rebalancing process. Given the interpolation between changes in net supply and Brent crude, we update our crude oil forecast to $55/bbl.-$65/bbl. with a base case of $60/bbl. for 2018.