Oil prices are predicted to close out 2017 around 15% up, and the market seems more stable than it has in years. The question is: What does 2018 have in store for us?
Many experts think 2018 will bring more of the same – inventory declines, moderate shale growth, a slow increase in oil prices and potentially the end of the OPEC deal. All this being said, a lot remains uncertain.
Here are five key things to pay attention to in 2018:
1. U.S. Shale Growth
We all know that U.S. shale output is continuing to rise, but nobody knows for sure at what magnitude it will grow. At the beginning of 2017, outlets such as EIA and IEA made bullish estimates for shale output, with the EIA predicting U.S. output to average 10 million barrels a day in 2018.
As 2017 wore on, many warning signs began to pop up, raising many questions about the health of the shale industry. Drilling costs were on the rise once again; a few shale companies ran into operational issues; drilling activity diminished when prices dropped below $50 per barrel, which was an indication that the average breakeven prices of the shale industry were not as low as once thought; rig count dipped; and investors started wanting more restraint and a slower pace of drilling. All of these problems combined, many started to believe shale was sputtering.
With this in mind, recent data really suggest that shale is back on track with strong production gains in September. Recent December reports from IEA and OPEC predicted that U.S. shale would add 870,000 bpd and 1mb/d of new supply in 2018. These estimates threaten to overwhelm demand growth but to what extent the actual increase lives up to expectations remains to be seen and will help determine the pace of rebalancing in 2018.
2. OPEC Compliance
OPEC production dropped in November for the fourth month in a row, this time falling by 130,000 bpd from a month earlier. This sharp decline puts the group’s compliance rate with the production reductions at 115%, the highest rate yet. OPEC’s ability to stay with its commitments is a positive sign heading into the next year that they’ll keep compliance rates high. To be clear, involuntary dips in Venezuela are somewhat hiding less-than-100% compliance from Iraq and the UAE, but a reduction of supply is still a reduction of supply.
The real question is the long-term resilience of high compliance throughout 2018. If the oil market rebalances suddenly, OPEC members might be led to abandon their pledges, tempted by higher oil prices. Russia has signaled that it is more than ready to leave the deal once inventories reduce to average levels once again. We must also consider the opposite end of the spectrum as well: a steep decline in oil prices could tempt members into cheating as they become desperate for more revenues.
3. The OPEC Exit Strategy
OPEC brought much-needed stability to the oil market through its determination to preserve output limits, and the strong cooperation, particularly between Saudi Arabia and Russia, relieved the oil market at the last OPEC meeting.
Even so, both countries did not detail their OPEC exit strategies, giving the June 2018 meeting, even more, weight, especially as the inventory surplus reduces. Leaving the production cuts behind is highly dangerous as even the slightest hints of a return to full production could scare jumpy oil traders. Top OPEC officials were hopeful to push off the conversation for this reason alone, however, by Q3 of 2018, they won’t be able to avoid the issue any longer. It’s likely OPEC will choose some kind of glide path which is a gradual reduction of the production limits, but we won't know for sure until then.
4. Fluctuations in Inventories
OPEC’s 2018 strategy will largely depend on what happens to global inventories. OECD commercial stocks decreased by more than 40 million barrels in October, setting total stocks at 2,940 million barrels, the weakest level in more than two years. The stock surplus is now near 100 million barrels which is more than the five-year average, down two-thirds from the beginning of 2017. It's likely that the large surplus will be erased during 2018, at which point OPEC will be under pressure to abandon its production limit agreements.
However, the IEA said in its December Oil Market Report that it anticipates inventories to start rising again in 2018, mostly because of blistering increase from U.S. shale. In the first half of 2018, the IEA predicts it will see inventories increase at a pace of 200,000 bpd. If the agency is right, zeroing out the surplus could prove difficult.
5. Unpredictable Incidents
All of these forecasts and predictions fall by the wayside should supply disruptions occur. Just days ago, cracking along the Forties pipeline caused a shutdown, and the pipeline's operator announced force majeure on oil shipments. The 450,000-bpd pipeline could be down for weeks which will lead to closures at North Sea oil fields. This event is exactly the type of incident that can catch the oil market off guard, causing a sharp and sudden price increase even if the rest of the world is operating just fine.
There are plenty of possible flashpoints that could lead to supply outages in the next year. The most obvious is Venezuela, which is experiencing steep and continuing declines. Venezuela's output fell by 41,000 bpd in November from a month earlier, after experiencing a decrease of 26,000 bpd in October 2017.
Production in the country is at a 30-year low and is moving south. Other outages are possible in unpredictable countries like Nigeria and Libya. Additionally, any conflict between the U.S. and Iran would be an entirely different animal, with serious implications for the oil market. Then, other potential outages are unpredictable altogether.
Incidents like the crack in the Forties pipeline, the spill from the Keystone pipeline in the U.S. and the massive wildfires in Alberta in 2016 are just a few examples of incidents that nobody saw coming. It only takes one vital disruption to upend even the most carefully predicted oil forecast.