The oil markets surprised this past year with higher-than-anticipated prices, and next year will likely bring even more unexpected events and volatility. Below are some of the top market developments of the past year and key issues for 2018.
- Oil prices rallied sharply during the second half of the year. Global oil prices fell to below $45 per barrel in mid-June but will finish the year in the mid-$60s. International benchmark Brent is set to average in the mid-$50s for 2017, approximately 23 percent above year-ago levels. When prices reached their lows in early summer, a number of analysts revised their forecasts downward and some speculators bet against OPEC’s strategy—but markets defied expectations.
- OPEC and its allies stuck to their production cut. Market participants had initially been skeptical about OPEC and its non-OPEC partners following through on their agreement to restrict global supply by two percent. The cartel has dealt with inconsistent compliance over the decades, but to the surprise of many, OPEC producers mostly adhered to their deal in 2017. In fact, compliance in November for the entire group averaged 115 percent.
- Commercial inventory declines accelerated. Commercial crude inventories in the U.S have fallen by 17 percent from their high earlier this year, and the country’s petroleum stocks are down by more than 100 million barrels since June. Total OECD commercial inventories have also fallen sharply, declining to their lowest levels since mid-2015. When it cut production, OPEC stated clearly that its main goal was to reduce the OECD inventory overhang.
- Hurricanes knocked out important infrastructure on the Gulf Coast. Hurricanes hitting the Gulf Coast in August and September caused damage and extended outages at a number of refinery facilities and shut in oil and gas production. After Hurricane Harvey hit the Houston area, national gasoline prices surged, and in Texas, there were supply shortfalls at some gas stations throughout the state.Petroleum prices returned to normal a month after the outages, but consumers had to contend with price distortions and the country was reminded of its energy security vulnerabilities.
- Geopolitical risks and unplanned outages increased in significance. A host of unanticipated events increased prices throughout the year. Venezuela’s production fell sharper than expected due to rising political and economic instability. Iraqi forces reclaimed oil fields in Kirkuk that the Kurdistan Regional Government (KRG) held since 2014. Nigeria and Libya remain volatile and are producing below capacity. Just recently, the Forties pipeline system in the North Sea shut unexpectedly. While the market was oversupplied from 2014-16, markets ignored supply threats and unplanned outages, but these events increased prices this past year as OPEC cut and inventories fell.
Top Five Uncertainties for 2018
- OPEC’s pledge to reduce output through all of 2018. With oil prices above $60 per barrel, OPEC producers and its non-OPEC partners, particularly Russia, will have more incentive to cheat on their pledges. The failure to stick to their quotas could bring about the return of an oversupplied market and lower prices. Likewise, there are also questions of OPEC’s “exit strategy”—or how it will unwind its supply agreement. If all producers increase output at once, global oil prices could fall precipitously. On the flip side, given that fundamentals are tightening, continued high compliance throughout all of 2018 from the cartel risks pushing prices even higher.
- Will non-OPEC supply growth meet expectations? The U.S. Energy Information Administration (EIA) and the International Energy Agency (IEA) both say that non-OPEC growth will be enough to meet the rise in global demand. Their optimistic outlooks are dependent on U.S. crude production increasing sharply. The EIA sees U.S. output rising by almost 800,000 b/d to 10 million barrels per day (mbd), thanks to shale, and overall non-OPEC supply increasing by 1.7 mbd. Similarly, the IEA sees non-OPEC growth of 1.6 mbd. Supply growth of this magnitude would mostly offset the OPEC production cut and likely stabilize prices. However, if shale does not meet the high end of expectations, higher prices could be the result.
- OECD commercial stocks will remain a key metric for OPEC. The cartel has said that it wants to reduce OECD petroleum inventories by approximately 100 million barrels in order to “rebalance” the market. If shale growth meets expectations, inventories, however, might rise. The EIA says OECD stocks will grow by 43 million barrels in 2018. The agency misjudged the trajectory of inventories for 2017, reflecting how vastly oil markets changed over the course of the year. Last year at this time, the EIA said that OECD stocks would rise by 20 million barrels in 2017. Instead, they fell by 25 million barrels. If shale performs lower than projected or oil markets see an increase in unexpected outages, stocks could continue to fall sharply.
- Global oil demand set to grow sharply once again. EIA, IEA, and OPEC see demand rising by 1.3-1.6 mbd in 2018, expanding on strong growth buoyed by weak oil prices since 2014. The price rise to above $60 will not negatively affect demand. In fact, the higher price could actually support demand given that oil-producing areas are major contributors to growth. U.S. demand is expected to rebound back above 20 mbd for the first time since 2007 and total global demand should rise above 100 mbd.
- Unplanned outages and geopolitical uncertainty risk increasing prices. Venezuela’s production will likely decline further, tension between Erbil and Baghdad could continue to negatively impact exports, and it’s uncertain how Saudi Arabia’s initial public offering, set to move forward in 2018, will impact global markets. Just this week, Nigeria’s oil union began a nationwide strike. The Forties pipeline outage still hasn’t been resolved. The significance of geopolitical risks is magnified by the ongoing OPEC cuts and sharp declines in inventories. Supply disruptions anywhere globally will impact consumers in all markets, as evidenced by a string of outages throughout 2017 that lifted prices.