A collapse of production in Venezuela, aggressive production curtailments from OPEC+, relatively strong demand and an economy humming along – and oil prices are still sharply below the highs seen last year.
To be sure, oil has bounced just about to the highest level since November, and a confluence of bullish forces seem to be pushing prices in an upward direction. But in years past, news that an oil producer like Venezuela suddenly saw production fall from over 1 million barrels per day (mb/d) down to 500,000 or 600,000 bpd overnight would have sent prices skyward. Now crude jumps by a buck or so.
The reason for the relative restraint is that the market has been anticipating U.S. shale production to grow at an unchecked rate. In January, the EIA predicted the U.S. would average 12.1 mb/d of oil production this year. A month later, the agency revised that forecast up by a massive 300,000 bpd to 12.4 mb/d. It was a familiar narrative. U.S. shale continues to exceed prior expectations.
However, the EIA just downgraded its forecast for the first time in six months. The latest Short-Term Energy Outlook sees output averaging 12.3 mb/d. It’s a rather minor downward revision, but the direction is important.
The series of spending cuts by U.S. shale producers may actually slow down the drilling machine. “This is just the beginning,” Phil Flynn, senior market analyst at Price Futures Group Inc., told Bloomberg. “The reality of the situation is that a lot of these guys are not making money and are having a hard time keeping these production levels up. Any pullback is going to make it harder to keep that upward trajectory of oil production moving higher.”
If U.S. shale begins to slowdown, it could remove one of the key barriers to higher prices. The Permian is the overarching factor that forecasters sight when predicting a well-supplied or even an oversupplied market. The oil majors are ploughing more and more money into West Texas, but small and medium-sized drillers are struggling.
Without U.S. shale crowding out other news, traders may begin to focus on some worrying hotspots around the world, flashpoints that seem to be multiplying. “Despite the appearance of extreme calm, we think pressure for an upside move has been building,” Standard Chartered analysts wrote in a note. “The oil market has, in our view, been very slow to focus on and price in a significant fall in Venezuela’s crude oil output due to power shortages. We think Venezuela’s output has fallen below 500 thousand barrels per day (kb/d) over the past week, down from averages of 1.1 million barrels per day (mb/d) in February and 1.2mb/d in January.”
Other analysts are also pointing out that there is somewhat of a disconnect between the mood of the market and the bullish factors at play. The “US oil rig count is declining, with shale oil focus shifting increasingly towards ‘show me the money’, i.e. they can no longer grow production through piling up more debt,” Bjarne Schieldrop, chief commodities analyst at SEB, wrote in a statement. “Further on the bull side, OPEC+ continues to deliver on pledged cuts and will likely decide to manage the market also in H2 2019 when they meet in April.”
Schieldrop said that the looming prospect of NOPEC legislation in the U.S. Congress, which targets OPEC, is a downside risk to oil.
Meanwhile, taking a broader look at forces outside of the oil market, Bank of America Merrill Lynch also comes to the conclusion that oil prices could edge up, despite some headwinds. “True, demand remains a concern. Looking at PMIs broadly, there has been a major deceleration in growth momentum. But the big reversal in Fed and ECB monetary policy expectations, coupled with increased fiscal stimulus in China, should support global growth in 2H19,” BofAML analysts wrote. “As such, we still see Brent prices averaging $70/bbl this year.”