In the meantime, the OPEC and non-OPEC producers’ (notably Russia) coalition met on 30 November 2017 and agreed to extend its production cuts through year-end 2018, with the goal of normalising inventories. The almost uninterrupted downward trend in US inventories (when stocks usually tend to build up in wintertime, Chart III) is already a good indication that this goal might be met over the course of the year. The group made clear that it wants to act as a market stabiliser, limiting oil price downside in the short to medium term. Financial constraints within OPEC (we estimate a production-weighted fiscal breakeven for OPEC around USD 65/bbl) and the need for a stable oil price for the Russian recovery to extend in an electoral year are likely to ensure high compliance among the main participants.
Turning to the US, latest datapoints showed that shale production surged beyond the peak of 2015 (Chart IV). Admittedly, these strong figures may be partly attributable to a catch-up following weeks of post-hurricane shutdowns. Most of the additional supply came from a rise in rigs productivity (in the Permian basin for instance, Chart V) rather than from an increase in rig count. We believe the US shale production will exceed 1Mb/d in 2018 – well above the 2011-2017 average (0.5 Mb/d), but below the 2014-2015 peak (1.4 Mb/d). It is worth mentioning that US shale companies hedge their output at a 12- to 24-month horizon and despite the current backwardation, futures contract levels are now close or above their marginal costs1 – likely to prompt additional production. However, with US shale producers asked by shareholders to focus on free cash flow generation, financial discipline is key to the strategy of most US E&P, ultimately containing capex for the coming quarters.
As a result, our supply/demand estimates suggest that we are beginning the transition away from market oversupply, with the physical market moving into deficit (or at least being balanced) in 2018. Still, robust fundamentals are already priced-in to the extent that we do not see any catalysts for a well-entrenched upward trend (absent a sharp cut-off of Venezuelan production but for now a continued decline offset by other OPEC members’ output seems the most likely scenario). Besides, the market seems to focus on the stability of the rig count rather than on the strong US supply figures for the time being. As such, current prices are subject to a downside risk in our view. We thus expect oil prices to remain well-supported by fundamentals, albeit at lower levels (Brent at USD 64/bbl). The US benchmark (WTI) should continue to trade at a discount compared to its European counterpart as moving oil from Cushing to the Gulf Coast has become more expensive on growing transportation constraints. Yet some new infrastructure projects should be completed soon, leading to a slightly tighter spread in the coming months.
Structurally, we think that US shale producers act as an anchor for oil prices at around USD 55/bbl in the long-term, warranting the backwardation of the curves. This means that spot price returns might become limited. Investors wishing to maintain their long position over time should, however, enjoy a positive carry in 2018.
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