Changing oil dynamics

February 13, 2017 10:22 AM
Daily Energy Markets Report

Crude oil dynamics are changing as rig counts rise, oil discoveries fall and OPEC compliance to production cuts are at an all-time high. Despite short-term worries about a U.S. glut, global oil inventories are on a path to a major tightening scenario and shale oil production alone will not change that. 

While the market looks to shale to meet demand needs of the future, cutbacks in capital spending on more rational projects are creating a potential shortage in the years to come. The Financial Times reported that global oil discoveries are at a 60-year low, hitting home a concern that I have had about the long term prospects of meeting oil demand growth. The FT reports that only 174 oil and gas discoveries were made world wide last year.

Even as U.S. oil rig counts rose for the fourth week in a row by eight to 591 and according to Baker Hughes, the highest levels since November of 2015, the ability of shale to meet future global demand growth is not possible. While the market seems comfortable with supply prospects in the short term, we are headed toward a tightening market and a potential major price spike a few years down the road.

This comes as OPEC compliance is at a record high of 92% per Kuwait and it looks increasing likely that OPEC is going to extend the production cuts into the end of the year. A lot of talks behind the scenes and now Reuters is reporting that Russia will decide in April or May on whether to extend the output cut deal with OPEC, Energy Minister Alexander Novak told reporters, per a report from state news service RIA Novosti.

The IEA says OPEC reduced output by 1.12 million barrels a day to 29.93 million a day. and the market is waiting to see if OPEC in their report will confirm that compliance. We tried to tell the world that these OPEC cuts were coming and that they would be complied with, but it seemed that no one wanted to listen. Now, with OPEC cuts ahead for the rest of the year, the world will be looking to U.S. shale producers to fill that void. Yet, what they are going to find out is that shale will not be able to fill that void. Even if shale producers double their expected output it will only come at an increase of 6000,000 barrels a day, a far cry from the 1.12 million barrels that OPEC is looking to take off.

While U.S. inventories are bloated, global inventories are falling. As I have said before, the spread between U.S. crude oil and products and global oil and oil products will inspire massive exports of oil out of the U.S. and we will see record exports happen next year. This may be enhanced by President Donald Trump’s import taxes slowing U.S. oil imports.

We said a year ago that the oil market is putting in a generational bottom. While in the short term we see influence from the dollar and weather, the long term is we are cutting back too far on investment at a time when global demand will be soaring. The world is finally crawling its way out of the great recession and it appears that we are underestimating demand growth over the next decade and overestimating the ability of shale oil to meet those needs. Once again, oil has moved out of a bust cycle and entering a boom cycle. It seems we never learn even as oil has had its booms and busts since the beginning of the oil era.

About the Author

Phil Flynn is a senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. Phil is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets.