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Global oil balance to loosen considerably in 2015

Hydrocarbon Engineering,

The US Energy Information Administration’s (EIA) November Short Term Energy Outlook (STEO) projects that Brent crude prices will average US$ 83/bbl in 2015, US$ 18/bbl lower than last month’s outlook for 2015. STEO projects prices to remain in the US$ 80 – US$ 90/bbl range next year, bottoming out under US$ 82/bbl in the second quarter when balances are loosest and then increasing during the second half of 2015 to average US$ 86/bbl in the fourth quarter. Even with the downward revision to the STEO price forecast, second to fourth quarter 2015 oil price projections remain within the market derived 95% confidence interval published in the September STEO before the recent fall in oil prices.

The lower price forecast in the November STEO reflects significant changes to the global oil balance. Compared to last month’s outlook, 2015 global liquid fuels demand in the November STEO declines by 200 000 bpd to average 95.2 million bpd, reflecting a weaker global macroeconomic outlook. In the November STEO global production increases by 200 000 bpd to 92.9 million bpd in 2015, primarily due to a smaller forecast decline in Saudi production.

The combination of robust US production growth, a return of disrupted Libyan production despite recent setbacks, weakening expectations for the global economy – particularly in China – and seasonally low refinery demand has weighed on oil prices. More recently, indications from Saudi Arabia that it will not operate as the unilateral global swing supplier have put further downward pressure on traders’ views of the market. Signs of willingness of other OEPC members to trim production have been scarce. Together, these conditions point to a much looser global supply/demand balance in 2015. However, actual price outcomes reflect a number of highly uncertain and inter-related factors, particularly OPEC production, global oil demand growth, and the responsiveness of marginal production, especially US shale, to lower prices.

The market assessment of these factors is reflected in the wide market derived confidence interval for crude oil prices implied by the value of futures and options contracts. Options written on West Texas Intermediate (WTI) futures contracts offer insight into market participants’ assessment of possible price movements. Note that the Brent options market is not sufficiently liquid to provide meaningful information on implied volatility beyond the prompt month. As of the five day trading period ending 6 November, implied volatility for the February 2015 WTI futures contract averaged 28%, resulting in a calculated 95% confidence interval of US$ 63 – US$ 99/bbl.

Changes in the forecast of Saudi Arabian oil production are crucial to the revised outlook and a major source of uncertainty in the year ahead, according to EIA. Saudi Arabia has indicated interest in preserving market share rather than unilaterally carrying the burden of cutting production to balance the global market. In addition, to numerous statements by high level Saudi officials downplaying recent price declines, the Kingdom has maintained robust production past the peak summer domestic demand season, choosing to reduce the Official Selling Price (OSP) of its crude to maintain market share rather than scale back production to balance supply from the US and Libya.

Taken together, these actions send a message ahead of the 27 November OPEC meeting indicating that members cannot continue to expect Saudi Arabia to balance the market alone, providing at least the potential for shared OPEC production cuts while simultaneously shifting pressure onto marginal producers to cut production to accommodate increasing supply from elsewhere.

As a result, in the November STEO EIA has revised the forecast decline in 2015 Saudi production. Output is now expected to remain above 9 million bpd throughout 2015. While the STEO still expects Saudi Arabia to cut production from current levels, the outlook takes into account the Kingdom’s recent emphasis on maintaining market share. With some of the lowest cost per barrel production in the world, and cash reserves approaching US$ 1 trillion, Saudi Arabia is better positioned to withstand a lower oil price than other producers and can make up some of the lost revenue from lower prices by maintaining supply volumes, the EIA reports.

With a looser supply/demand balance weighing on prices, STEO expects marginal producers will be unable to meet previous expectations for supply growth. The current price outlook does not support new development of the most expensive, marginal barrels such as Arctic, ultra deep water, and some oilsands. However, given the long lead time and substantial investment required, these types of projects are unlikely to be affected within the 2015 STEO forecast period. The short timeframe between the start of drilling and first production from US shale wells make them the first production likely to be impacted.

However, shale production costs have declined rapidly as techniques improve and infrastructure develops, and in falling oil price environmental drilling and completion costs will fall, making these wells cheaper to develop. Additionally, the most marginal, inefficient producers account for a disproportionally small volume of production. During the next several months, hedging, sunk cost calculations, and redeployment of rigs from more speculative plays to the most productive areas will mitigate much of the effect of lower prices. However, STEO expects that the impact from lower oil prices will increase as time passes, with the level of US shale production in the fourth quarter of 2015 expected to be 100 000 bpd lower than forecast in last month’s STEO. Nevertheless, US crude oil production is still expected to increase by 850 000 bpd in 2015 to average 9.4 million bpd.

Adapted from a press release by Emma McAleavey.

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