Expectations that a much anticipated rebalancing of oversupplied oil markets would take hold in the third quarter of 2016 have been dashed after the International Energy Agency sharply revised its earlier projections in its latest monthly report. The IEA’s September Oil Market Report forecasts that the unprecedented supply glut weighing on oil prices for the past two years will continue beyond the first half of 2017 due to surging OPEC production, non-OPEC supplies more resilient than previously expected, and slower global demand growth. As a result, global oil stock levels breached new highs in August, according to the IEA.

The revised projections sent a shockwave through the markets and will add fuel to OPEC’s informal meetings set to take place in Algiers in less than two weeks. The latest data suggests oil prices will stay lower for longer, making it all the more urgent for oil producing countries to reach an agreement to moderate burgeoning supply growth. Significant differences remain among the member states and key non-OPEC producers such as Russia over whether to cut or just freeze production levels.

The IEA dampened expectations of the possibility of a balanced market until at least mid-2017. The report suggested “that this supply-demand dynamic may not change significantly in the coming months. As a result, supply will continue to outpace demand at least through the first half of next year. Global inventories will continue to grow. OECD stockpiles in July smashed through the 3.1 billion barrel wall. As for the market’s return to balance – it looks like we may have to wait a while longer.”

Oil prices declined in reaction to the report’s conclusion, with futures prices for West Texas Intermediate (WTI) declining by $3.25 per barrel (bbl), to around $43/bbl, since the release on September 13. The more bearish market sentiment has forecasters predicting a price range for international benchmark Brent crude oil futures of $40-50/bbl at best compared to previous expectations of $50-60/bbl. Goldman Sachs expects prices to trade in a tighter range of $45-50/bbl over the next 12 months.

The Waiting Game

The IEA’s Oil Market Report asked: “When will the world oil market return to balance?” It answered: “With the price of oil at current levels, one would expect supply to contract and demand to grow strongly. However, the opposite now seems to be happening. Demand growth is slowing and supply is rising. Consequently, stocks of oil in OECD countries are swelling to levels never seen before.”

Global oil demand is projected to increase by 1.3 million barrels per day (mb/d) to 96.1 mb/d in 2016, down 100,000 barrels per day (kb/d) on the previous forecast due to “a more pronounced 3Q16 slowdown,” according to the IEA. Demand growth is forecast to ease marginally, up by 1.2 mb/d to 97.3 mb/d in 2017. The IEA cautioned that “underlying macroeconomic conditions remain uncertain.” A sharp slowdown in third-quarter demand helped upend the previous forecast of “a hefty draw” in stocks for the period, which would have been the first after 10 quarters of uninterrupted builds. Demand growth in China and India is “wobbling,” said the IEA, concluding there has been “a slump in oil demand growth from a robust 1.4mn b/d in the second quarter to a two-year low of 800 kb/d in the third quarter.” Asia accounts for two-thirds of the downward revision and Europe accounts for the remainder. Demand growth slowed in India due to a combination of heavy monsoon rains and sputtering industrial activity, the report indicated.

Notably, Chinese demand was flat in the third quarter – the first no-growth quarter since the great recession of 2008-09. A 200 kb/d downgrade to Chinese demand, however, largely reflected one-off, temporary factors such as the government’s plan to ensure “blue skies” for the September G20 meeting in Hangzhou. The government instructed factories in the nearby regions to halt operations ahead of the meeting in order to clear pollution from the air, which in turn curtailed industrial oil use. China has a history of implementing temporary measures to clean the air before hosting major international events. Heavy flooding also curbed demand for transport fuels. The IEA forecasts a rebound in China’s demand growth of 300 kb/d for the fourth quarter, to a record 11.8 mb/d, with the upward trajectory continuing in 2017.

The supply side of the picture is equally, if not more so, undermining market sentiment. Global oil production jumped by more than 1 mb/d between the second and third quarters of 2016 despite lower oil prices, the substantive slashing of investments, and the huge redundancy of employees in the oil industry. High-cost non-OPEC producers have been hit particularly hard, according to the September 14 inaugural annual report on energy investments around the world from the IEA. The IEA estimates that around 1.4 mb/d has been shut-in since the start of the price collapse in mid-2014. Approximately half the investment cuts have been made by independent U.S. producers. That said, after a projected decline of 840 kb/d to 56.7 mb/d this year, growth in non-OPEC supplies is expected to resume in 2017, rising by almost 400 kb/d to 57 mb/d.

The sharp loss in non-OPEC supplies in 2016 has been more than made up by surging OPEC production. OPEC production has jumped by a staggering 2 mb/d since OPEC adopted its market share strategy in late 2014. The relentless rise in OPEC supplies has been a major factor in derailing earlier forecasts for a stock drawdown. The IEA estimates that Saudi Arabia and Iran have each raised oil output by over 1 mb/d since late 2014. In fact, OPEC’s low-cost (around $10/bbl) Middle East producers – Saudi Arabia, Kuwait, the United Arab Emirates, and Iraq – are all at or near all-time highs, with total output by the group reaching a lofty 33.5 mb/d in August. While Iran’s post-sanctions rise in production has been swift, output levels have largely plateaued now at around 3.65 mb/d and the IEA forecast does not expect the country to reach its 4 mb/d target until 2020, assuming it is able to attract foreign investment and technology.

Surging OPEC production and a slowdown in global oil demand have combined to delay further a rebalancing of oversupplied markets, with global supply projected to rise for the fourth consecutive year in 2017. Though less than half the staggering 1.7 mb/d stock build seen in 2015, supply is currently projected to outstrip demand by around 500-600 kb/d in the second half of 2016 and early 2017 before gradually shrinking to less than 100 kb/d by the end of 2017. Forecasts are inherently prone to revisions, from temporary events distorting supply and demand expectations or because new data becomes available a few months to over a year later. In response, between now and the end of 2017 supply, demand, and stock data will ebb and flow but there is little doubt that directionally a rebalancing is underway.

OPEC’s Iran Problem

The IEA’s revised projections, and along with them a more bearish market sentiment, have compounded the multitude of challenges OPEC will have to tackle at its informal ministerial council meeting in Algiers on September 26-28. The 15th International Energy Forum will bring together some 600 ministers, senior government officials, representatives from international organizations, and oil executives from the 73 member countries. The forum does not issue any formal communiques and this year is likely to be overshadowed by the scheduled talks between OPEC and non-OPEC states on the sidelines of the gathering.

The major issue overhanging the planned talks is the rebalancing of supply and demand fundamentals now underway. The relentless rise in global oil stocks has slowed dramatically in the second half of 2016 and will eventually start contracting as global demand growth overtakes rising supplies. But a complete rebalancing and working down of the unprecedented surplus of inventories accumulated since 2014 will take time; though how long it will take is difficult to assess. One-off factors like China’s “blue sky” policy may provide temporary setbacks or supply outages may speed up the process. For some OPEC countries like Saudi Arabia the rebalancing trend is going in the right direction. But for other more financially distressed members such as Nigeria and Venezuela the market recovery is taking too long. Russia is also drawing down its financial reserves to offset lower oil revenue paid to the government. There will be no shortage of issues to discuss in Algiers, but reaching a consensus on action to stabilize markets will be extremely difficult.

High-level meetings between Saudi Arabia and Russia and bilateral meetings between OPEC officials have been taking place over the past month, which have served to prop up prices, with WTI gaining almost $5/bbl since Saudi Arabia’s Minister of Energy, Industry, and Mineral Resources Khalid al-Falih on August 11 signaled his support for possible action to help balance the market. The latest round of meetings largely focused on possible actions to discuss in Algiers and the outlook for the market. The OPEC Secretariat also published on September 12 its Monthly Oil Market Report, which closely mirrored the IEA’s report. OPEC forecasts demand growth of 1.2 mb/d for 2016 and 2017. Projections for non-OPEC supplies were also raised for both years, with supplies now forecast to decline by a smaller 610 kb/d in 2016 but increase by 200 kb/d in 2017.

The flurry of meetings have produced bullish market headlines but little else so far. Russian President Vladimir Putin and Saudi Arabia’s Deputy Crown Prince Mohammed bin Salman met on the sidelines of the G20 meeting in China to discuss cooperation. This was followed by a meeting between Falih and his Russian counterpart Alexander Novak at the same gathering where a memorandum of understanding was signed to set up a working group to study the market. However, immediately after the signing, Falih dismissed the need to rein in production, saying market forces were starting to rebalance the markets. Meanwhile, Novak made comments along the same lines. For all the pomp and circumstance, there appeared to be no real meaningful initiatives underway between the two powerhouses to achieve their stated goal of stabilizing the market.

Iran is once again at the center of the long-running disagreement between Saudi and Russian officials over whether it needs to be part of any agreement to freeze production. Russia said it is ready to cooperate with OPEC, when and if OPEC reaches a unanimous decision. In the absence of OPEC’s unanimity, Russia will stand on the sidelines. Cementing the Saudi position, Foreign Minister Adel al-Jubeir said on September 8 that his country would agree to a production freeze if all other producers committed to it, but added, “I believe again the spoiler will be the Iranians. You can’t expect other countries to freeze while you reserve the right to increase your production.” Iran wants a 15 percent share of OPEC production, as well as to be exempted from an OPEC decision in Algiers. This means, in effect, no unanimous decision. Accordingly, OPEC is not expected to reach a decision to freeze production, let alone cut supplies, in Algiers.