Oil Market: Supply Shortages Reinforce Cautious Forecasts

BMI View : We started the year cautiously with our crude oil production forecasts. Our caution has been justified, with limited upsides to production in the first four months of the year. We have downgraded our global crude oil production forecast to reflect persistent outages amongst the world oil producers. We have also downgraded oil consumption for several of the largest Asian consumers such as India, South Korea and Japan, in line with more bearish macroeconomic expectations; however an upgrade to the US oil consumption for 2014 has offset the Asian downgrades.

Over the first quarter of 2014 we downgraded our oil production forecasts for important producers (regional and global) like Saudi Arabia, Iran, Angola, South Sudan, Denmark, China, USA, Venezuela and Azerbaijan. We have decreased our oil production forecast by 900,000 barrels per day (b/d), while we have slightly increased our global oil consumption by 235,000 b/d. Our global crude oil supply/demand balance has therefore slipped into a deficit for the year of 625,000 b/d.

With the 2-year setback announced at the Kashagan oil project in Kazakhstan, a prospective 180,000b/d to 200,000 b/d will not flow to the markets. This would have been the largest greenfield addition to global oil supplies this year, but we have pushed it back to late 2015 in our forecasts and there is a high risk of further delays.

Persistent Outages Create A Deficit
Global Oil Demand, Supply and S/D Balance, 000s b/d

BMI View : We started the year cautiously with our crude oil production forecasts. Our caution has been justified, with limited upsides to production in the first four months of the year. We have downgraded our global crude oil production forecast to reflect persistent outages amongst the world oil producers. We have also downgraded oil consumption for several of the largest Asian consumers such as India, South Korea and Japan, in line with more bearish macroeconomic expectations; however an upgrade to the US oil consumption for 2014 has offset the Asian downgrades.

Over the first quarter of 2014 we downgraded our oil production forecasts for important producers (regional and global) like Saudi Arabia, Iran, Angola, South Sudan, Denmark, China, USA, Venezuela and Azerbaijan. We have decreased our oil production forecast by 900,000 barrels per day (b/d), while we have slightly increased our global oil consumption by 235,000 b/d. Our global crude oil supply/demand balance has therefore slipped into a deficit for the year of 625,000 b/d.

With the 2-year setback announced at the Kashagan oil project in Kazakhstan, a prospective 180,000b/d to 200,000 b/d will not flow to the markets. This would have been the largest greenfield addition to global oil supplies this year, but we have pushed it back to late 2015 in our forecasts and there is a high risk of further delays.

Persistent Outages Create A Deficit
Global Oil Demand, Supply and S/D Balance, 000s b/d

The negotiations for Kurdish oil exports via Turkey have been postponed until after the Iraqi elections at the end of April, therefore any upside to Iraq's deliveries is pushed further into 2014, probably 2015. For 2014, Iraq is targeting output of 4mn b/d; however, due to the restricted output from Kurdistan and outages at Kirkuk-Ceyhan pipeline we are more cautious in our outlook, forecasting production at around 3.4mn b/d.

Iran remains the 'wild-card' in the coming year. While we do not anticipate sanctions to be lifted to a degree that will have a powerful impact on the country's oil industry this year, nor do we expect that - even if sanctions were lifted - the country would be able to ramp-up production overnight, we do believe diplomatic momentum will dictate OPEC discourse, price movements and capex planning for major producers in the region.

The upside will come from Libya and the recent agreement to re-open the ports on the eastern coast. The port of Zueitina is due first, probably in May, after damages to its infrastructure have been assessed, according to the Libyan Justice Minister. The ports of Marsa al-Hariga, Ras Lanuf and Sidra are also due to open when talks between the rebels and the government are concluded. The reopening of the Zueitina and Marsa al-Hariga ports could, under an optimistic scenario, see as much as 180,000 b/d of crude re-enter the global market. Added to this, the possibility that the larger Ras Lanuf and Sidra oil terminals could reopen adds further upside risk for Libya's oil output, with over 500,000 b/d of further potential capacity becoming available. We have not factored these gains into our 2014 forecasts as it could prove to be a false start. If all of these expected volumes make it to market, then our 2014 deficit will be nearly eliminated.

OPEC Reconsiders Modus Operandi

Saudi Arabia's signal that it would step back from its traditional swing producer role highlights OPEC's response to shifting fundamentals in the global market. Reports are emerging that Saudi Arabia has signalled that any necessary curtailment of production by OPEC would have to come in a coordinated move. Traditionally, while in principle the cartel has to move in coordination and cooperation to alter supplies on the global oil markets, it has been primarily Saudi Arabia that has fluctuated its output. Given the tensions in play, the coordinated action Riyadh is seeking will be difficult to organise but may well be necessary. However, we note that Saudi Arabia's resolve not to go it alone would certainly be tested if prices dropped to below US$80/bbl.

Supporting this shift in strategy, there may well be growing recognition in Riyadh that, given the scale of the potential changes underway, acting independently may not be in its best interests of OPEC itself. In our view, the key challenges that OPEC must manage are:

  • Rising OPEC Production: Namely from Iraq, which is still outside the production quota system, but is on track for robust expansion of its output. This is already leading to tensions among other producers as they increasingly compete for market share in Asia. Other producers such as the UAE are also investing billions in raising upstream capacity.

  • Potential Return Of Iran: As we have noted previously, the removal of sanctions on Iran's oil sector would be a game changer and over time could see Iran return to pre-sanctions production levels approaching 4mn b/d. With Iran claiming to have secured an agreement at the most recent OPEC summit that would see other members 'make room' for a return of its crude should restrictions be loosened, the impact on the state of the global market could be dramatic.

More Could Be On The Way
Total Monthly Estimated OPEC Production, '000s b/d

The latest developments pose downside risks to our production forecasts for OPEC members, but could also put pressure on prices over the longer term should countries forgo planned upstream investment.

Production Outages Look Likely To Persist

Iraq, South Sudan, Libya and Kazakhstan are the main oil producers that presented a production challenge for 2013. Timely recovery in their volumes is uncertain.

  • The Kashagan field in Kazakhstan, the largest greenfield project in the world, came online for only a matter of a few weeks before being shut down due to technical problems. A full replacement of faulty pipelines will send the costs higher and delay production to end-2015 at the earliest.

  • The escalation of in-fighting between the military and rebel forces in South Sudan seems to have halted the majority of the country's production, with fighting taking place in the Unity and Upper Nile States, where the majority of oil is produced. South Sudan's government stated in early March that oil output has been slashed by 29% as a result of the fighting. Our expectation that violence would escalate further in spite of cease-fire talks has materialised with the situation going from bad to worse. Fighting - accompanied by massacres of civilians - continues unabated.

  • Continued challenges in Iraq's upstream environment put the country's plans for a big increase in oil production growth into further doubt. While the start of major upstream projects in the coming quarters highlights Iraq's potential, volatile production and weak gas production underscore the country's challenges. Although we expect strong growth in both oil and gas output over the course of our forecast period to 2023, we expect delays and setbacks to continue, causing production to underperform the country's raw potential. As a result, we have taken a more bearish production outlook of just under 3.4mn b/d for 2014, compared to an average of 3.5mn b/d previously and the government's target of 4mn b/d. Most recently, the security environment has deteriorated since sectarian tension flared up in Anbar province, raising another red flag with regards to Iraq's operating landscape.

Elsewhere, production gains in Asia, North America and Latin America will drive overall global production growth for 2014. We forecast global crude oil production to be 87.7mn b/d, lower than our previous forecast of 88.6mn b/d. US crude oil production will reach 11.3mn b/d in 2014, up nearly 5% y-o-y (though lower than the EIA's forecast for 12mn b/d). We are also watching the reform of Mexico's energy sector closely, which could also unleash a new wave of investment in the coming years.

Americas Spearheads Production Gains
% Change y-o-y in Crude Oil Production, by Region, 2014f

Global Oil Demand Picks Up

Demand will be more buoyant than in 2013, though BMI's Country Risk team's bearish view on Japan (downgrading real growth by 0.5%) has also prompted a downgrade in our oil consumption forecast for the country, which accounts for 5% of global oil demand. Somewhat offsetting the downgrade from Japan has been the upgrade to our US refined fuels consumption forecast, which accounts for 20% of global consumption. This is in line with healthier economic growth in the US. This is underpinned by a strengthening US consumer and stronger fixed investment growth - boosting real GDP growth to 2.8% from 1.9% in 2013.

Consumption of refined fuels (our measure of oil demand) across major emerging markets is going to increase at a healthy pace, offsetting muted growth from Western Europe and North America, both of which are seeing a structural decline or slowdown as energy efficiency rises (in the case of Western Europe it is compounded by a cyclical decline as a result of years of weak economic growth).

Global oil consumption for 2014 will reach 88.4mn b/d (up from our previous forecast of 88.14mn b/d) up 1.6% y-o-y, of which the US will account for 18.858mn b/d, China for 11.1mn b/d, Japan for 4.45mn b/d, India for 3.609mn b/d and Russia for 3.2mn b/d.

Emerging Markets Fuel Growth
Refined Fuels Consumption, '000s b/d

Capex Growth Cycle Shifting Gears

Globally, capex is exiting the cycle of growth of the past four years as international oil companies (IOCs) and larger independents seek to reap the rewards of their investment as a five-year project cycle (which started with a recovery in capex in 2010) is approaching an end. We anticipate a deceleration in capital investment growth in 2014 with companies adopting a more circumspect approach to budgetary planning, though not a year-on-year reduction in investment - since the pricing environment remains conducive. Our price forecasts see Brent averaging USD105/bbl in 2014 and WTI at USD98.5/bbl.

BMI Oil Price Forecasts, Annual Average, USD/bbl
2013 2014f 2015f
OPEC basket 105.90 101.75 100.00
WTI 98.00 98.50 99.00
Brent 108.70 104.75 102.00
Urals 107.90 102.00 101.00
Dubai 105.40 101.93 100.50
f=BMI forecast. Source: Bloomberg, BMI

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Since 2010, when the industry recovered from the downturn of 2009, capex has been increasing at an average of 12% y-o-y, according to data compiled by Bloomberg. However, following four years of rapid increases in capital spending by IOCs and national oil companies (NOCs), the mood seems to be turning. Indeed, development costs have increased in tandem with spending in recent years, as projects become more complex and skills shortages stretch the industry. According to data from Bloomberg, exploration costs rose by an average of 20% y-o-y in 2012 and 2011, and considering the similar growth trajectory in spending over 2013, we would expect a similar cost rise last year too.

A typical 5-year cycle in project development from exploration and appraisal (E&A) to commercial production means that a lot of investors are now expecting companies to begin consolidating the gains from the investment that started around 2010. We have therefore seen the industry discourse focus increasingly on investor returns and dividends. A case in point is French company Total, which announced a reduction in capex is in store post-2015 and that it will focus on cash flow from new developments that are due to come online.

There are divergent expectations in the market for 2014 E&P capex. Our review of the announced 2014 capex plans from IOCs and NOCs shows that the majority of companies are looking at lower capital spending in 2014 compared to 2013 (see table below). In a study on global E&P capex, Barclays estimates that 2013 capex (organic) reached US$680bn and that the figure will increase in 2014 by 6% to US$723bn. The largest oil field services companies also have given estimates that they expect capex in global E&P to rise between 8%-10% in 2014.

Announced Spending Budgets, US$bn
2013 Capex 2014 Capex
Royal Dutch Shell 46 37
Total 28 26
Gazprom 32 21.1
Statoil 19 20
BP na 25
ConocoPhillips 16 16.7
Chevron 42 39.8
Exxon 42.5 39.8
GazpromNeft 8.2 8.5
PTT (Thailand) 12 10
Pertamina na 7.9
Source: BMI Research

A survey of analysts by Bloomberg, however, reveals that the industry is expecting capex growth to decelerate in the coming years.

For 2014, the global capex consensus forecast is US$541bn (-0.5% y-o-y), rising to US$549bn (1.5% y-o-y) in 2015. Though the aggregate number is lower than the one quoted by the Barclay's analysis (Bloomberg data excludes unlisted NOCs) the trend clearly indicates an expectation that there will be a moderation in spending growth. This divergence in the outlook regarding capex plans is, in our view, a reflection of the uncertainty regarding demand trends as well as the future pricing environment.

Capex Growth Tapering
Global E&P Capex (Organic), US$bn
BMI

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