Crude: Spare production capacity going to all-time lows

Daily Energy Market Analysis

While the markets await the outcome from the Fed meeting and oil traders fret about whether OPEC and non-OPEC might raise production, as well as the weekly supply report, the biggest threat to the price of crude oil and the global economy may be the lack of spare oil production capacity. While the International Energy Agency (IEA) and the Organization of the Petroleum Exporting Countries (OPEC) and the Energy Information Administration (EIA) released reports that show they are confused about the outlook for demand, the truth is that OPEC and Non-OPEC decided to raise oil output, and the amount of oil that the world can bring on quickly will be almost non-existent.

Reuters reports that global spare oil production capacity could fall from more than 3% of global demand now to about 2%, its lowest since at least 1984, if OPEC, Russia and other producers decide to increase output when they meet on June 22-23. Some analysts say spare capacity could even fall below 2%, after years of low oil prices drove down investments in new production across the industry to a historic low. These numbers are very much in line with what we are looking at and it is a situation that we have warned was going to develop for some time.

In other words, the risk for oil price spike based upon whether or geospatial events is higher than it’s ever been. While the U.S. shale producers are the main reason that we have any spare capacity at all, their ability to sharply increase production in a short time to meet a supply disruption does not exist.

Speaking about weather outlook, we are on storm watch in the Gulf of Mexico. Top futures weather forecaster Michael Schlacter says that a disturbance in the Gulf of Mexico is very much like "Alberto" in May. The western Caribbean & Yucatan region continues to be ripe for Tropical development; we're monitoring disturbances that pose a risk to Gulf of Mexico. 

In the Eastern Pacific you have Hurricane Bud, which poses only minimal risk to oil installations; but according to Schlacter, it will bring storminess and copious rains to western Mexico and up into the Desert Southwest. This will act to enhance Ridging/Heat for the Pacific Northwest and USA East-of-Rockies.

So many oil agencies are reporting on the same things and sometimes adding more confusion. The IEA has a lower projection for global demand than any other agency. That should not be a surprise because they almost always do and they are almost always wrong. The IEA say that global oil demand growth for 2019 of 1.4 mb/d, similar to this year’s level., which they missed. Of course, they say there are downside risks: these include the possibility of higher prices, a weakening of economic confidence, trade protectionism and a potential further strengthening of the U.S. dollar.

They also revised its estimate for 2018 non-OPEC production growth to 2 mb/d and in 2019 we will also see bumper growth, albeit slightly reduced, of 1.7 mb/d.  Yet, even the IEA warns that spare production capacity will remain tight. They warn that exports from Venezuela and Iran could be 1.5 mb/d lower than it is today. 


Summer driving season

By now, consumers are seeing the effects of recent increases in crude oil prices at the pump. EIA’s June outlook expects regular gasoline prices to average $2.87 for the summer driving season, which marks a 46-cent increase from last summer’s average. However, EIA believes prices will generally decline after June, falling to an average of $2.84 per gallon by September.

Brent crude oil spot prices averaged $77 per barrel (b) in May, an increase of $5/b from the April level and the highest monthly average price since November 2014. EIA forecasts Brent spot prices will average $71/b in 2018 and $68/b in 2019. The 2019 forecast price is $2/b higher than in the May STEO. EIA expects West Texas Intermediate (WTI) crude oil prices will average almost $7/b lower than Brent prices in 2018 and $6/b lower than Brent prices in 2019. NYMEX WTI futures and options contract values for September 2018 delivery traded during the five-day period ending June 7, 2018, suggest a range of $52/b to $81/b encompasses the market expectation for September WTI prices at the 95% confidence level.

For the 2018 April–September summer driving season, EIA forecasts U.S. regular gasoline retail prices to average $2.87/gallon (gal), up from an average of $2.41/gal last summer. The higher forecast gasoline prices are primarily the result of higher forecast crude oil prices. Monthly average gasoline prices are expected to reach a summer peak in June of $2.92/gal and are forecast to decline gradually afterward to $2.84/gal in September.

EIA estimates that U.S. crude oil production averaged 10.7 million barrels per day (b/d) in May, up 80,000 b/d from the April level. EIA projects that U.S. crude oil production will average 10.8 million b/d in 2018, up from 9.4 million b/d in 2017, and will average 11.8 million b/d in 2019.

EIA forecasts that total U.S. crude oil and petroleum product net imports will fall from an annual average of 3.7 million b/d in 2017 to an average of 2.5 million b/d in 2018 and to 1.6 million b/d in 2019, which would be the lowest level of net oil imports since 1959.

EIA forecasts crude oil production from the Organization of the Petroleum Exporting Countries (OPEC) will average 32.0 million b/d in 2018, a decrease of 0.4 million b/d from the 2017 level. OPEC crude oil production is expected to increase slightly to an average of 32.1 million b/d in 2019. The increase in production in 2019 is expected to occur despite falling production in Venezuela and Iran. EIA assumes these decreases will be offset by increasing production from Persian Gulf producers, primarily Saudi Arabia.

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About the Author

Senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor.