The cloud of surplus oil supplies overhanging global oil markets for the past few years is finally lifting, making way for a more balanced outlook and removing a weighty problem that has added to downward pressure on oil prices. The rebalancing of the global oil market will gather pace in the second half of 2016 with the realignment of supply and demand fundamentals expected to take hold in 2017, the International Energy Agency forecasts in its latest monthly report. Oil supplies have been outstripping demand by just over 1.2 million barrels per day (mb/d) since early 2014. The return to a more balanced outlook is due to a combination of stronger than expected oil demand growth, lower non-OPEC production, and significant unplanned supply outages, according to the IEA’s June Oil Market Report. Earlier expectations that the surplus of supply over demand would be as much as 1.5 mb/d in the first half of 2016 have now been revised sharply lower to 800,000 barrels per day (kb/d), according to the report.

In its first forecast for 2017, the IEA sees oil supply and demand fundamentals strengthening further, with a drawdown in inventories forecast in the second half of the year, barring any surprises. This would be the first significant drawdown in stocks since 2013. Global oil demand is projected to rise to 97.4 mb/d in 2017, an increase of 1.3 mb/d over 2016 levels, led by strong gains in India, South Korea, and China, and to a lesser extent, the Middle East, according to the report. Indeed, non-OECD economies are expected to account for 1.2 mb/d of the 1.3 mb/d global growth forecast for 2017. IEA projections are based on data from the International Monetary Fund’s April World Economic Outlook and assume that global economic growth – a key driver of global oil demand growth – will average 3.5 percent in 2017.

On the supply side, non-OPEC production is projected to post a steep decline of 900 kb/d, to 56.8 mb/d. A modest increase around 200 kb/d, to 57 mb/d, is forecast for 2017. U.S. production is expected to account for just over 50 percent of the loss in 2016. The decline in prices from over $100 in mid-2014 to 12 year lows of under $30 per barrel (bbl) in January 2016 forced companies to shut in more expensive oil output. Production of U.S. shale oil, or light tight oil produced by hydraulic fracturing (fracking), is forecast to decline by 500 kb/d in 2016, to an average 3.8 mb/d, and fall by a further 200 kb/d, to 3.61 mb/d in 2017, according to the IEA. In 2017, most of the small growth in non-OPEC supplies is expected to come from Canada and Brazil.

While going forward a more balanced market is expected to emerge, a massive residual inventory has built up over the past few years and must be cleared from the market for oil prices to rise much above $50 to $60/bbl. Industry oil stocks held by OECD countries rose to 3,046 million barrels in April, the highest level on record, according to IEA data. Stock builds have averaged a high 1.2 mb/d from 2014 to April 2016, but from mid-2016 through 2017, inventories are expected to post only modest increases or decreases (less than 500 kb/d), which should gradually help reduce the surplus overhanging market.

Uncertainties Temper Outlook

Oil prices typically respond to the data released in the IEA’s closely watched oil reports, but June’s bullish forecast showing oil demand growth strengthening and global supplies tapering off was tempered by the wide array of uncertainties surrounding the forecast. Unplanned global supply outages have helped hasten the rebalancing of fundamentals but the IEA warned that a potential recovery in shut in production may tip the market into oversupply again. Unplanned global oil supply disruptions peaked at 3.6 mb/d in May, according to a new report from the U.S. Energy Information Administration. Year-to-date supply outages have averaged 2.8 mb/d, with OPEC countries accounting for 80 percent of the lost, EIA data show.

Shut in production in strife-torn Libya has averaged just under 1 mb/d so far in 2016, with output just 300 kb/d in May. In Nigeria, militant attacks on oil infrastructure in the volatile Niger Delta region reduced production by 500 kb/d this year, with output falling to a three-decade low of 1.4 mb/d in May, according to the EIA. In addition to the long running political dispute between Baghdad and the Kurdistan Regional Government that has curbed supply flows from northern Iraq, operational and weather-related problems at southern export terminals have combined to reduce the country’s volumes by an average 250 kb/d this year. Meanwhile, output from the Saudi Arabia and Kuwait shared Neutral Zone is down 500 kb/d following a dispute between the two countries over management of the fields that has been simmering for more than a year.

While OPEC oil exports may ebb and flow month to month, a long-term resolution to the political disputes and military conflicts affecting current supply outages in Libya, Nigeria, and Iraq will take time to resolve so a sudden return of supplies to the market is not anticipated. In any event, latest supply and demand data suggest even a partial recovery in outages can be absorbed into the market in the coming six quarters. The implied “call on OPEC crude and stock changes” is forecast to rise from an average 32.5 mb/d in 2016 to 33.4 mb/d in 2017 – a significant increase of 900 kb/d, according to the IEA’s June report. Near term, the estimated call on OPEC crude is forecast to rise to 33.1 mb/d in the second half of 2016, up by 400 kb/d from the first half of the year. The “call on OPEC crude and stocks” is calculated by the IEA as the arithmetic difference between total demand minus total non-OPEC supply minus OPEC Natural Gas Liquids.

OPEC Set to Increase Market Share

At their biannual meeting earlier in June, OPEC ministers maintained the status quo of basically noninterference in oil markets. OPEC adopted its hands-off production policy rather than try to defend prices in November 2014, with the expectation that lower prices would force the shut in of more expensive oil. The unwinding of costly production has taken much longer than expected but the strategy has now led the IEA to forecast a near 1 mb/d decline in non-OPEC supplies for 2016. The IEA’s latest forecast implies OPEC will supply the lion’s share of the 1.3 mb/d demand growth forecast for 2017. Indeed, some analysts believe that non-OPEC supplies will continue to decline by anywhere from 500 to 800 kb/d in 2017 compared to the IEA’s projection of a modest 200 kb/d recovery in output, which could raise the call on OPEC crude closer to 1.5 mb/d. Some analysts believe the massive cut in capital expenditures by oil companies in the wake of lower oil prices and contracting revenue will lead to further project delays while budget cutbacks have meant investments needed to maintain output at existing oil operations will lead to an acceleration of rates in mature oil fields.

Much will depend on oil prices sustaining levels closer to a range of $50 to $60/bbl to alter the downward trajectory of non-OPEC production. Oil prices briefly hovered around the $50/bbl mark in early June but have since edged lower on market worries over economic growth in Asia, the impact of the upcoming British vote on remaining in the European Union, and expectations of a stronger U.S. dollar. However, the emerging stronger supply and demand fundamentals have led investments banks to raise their price forecast, with both Goldman Sachs and Citigroup forecasting WTI futures prices to reach $50/bbl by the fourth quarter of 2016 and $60/bbl by the fourth quarter of 2017.

Despite forecasts for increased OPEC supplies in 2016, lower oil prices relative to 2015 are expected to reduce the producer group’s net oil export revenue to about $338 billion in 2016, compared with $404 billion in 2015 and less than half the estimated $754 billion in 2014, according to a new report from the EIA. However, in line with expectations for a modest oil price recovery in 2017, OPEC revenue is projected to recover to $415 billion, an increase of 22 percent over 2016 levels, EIA data show.

Oil market forecasts are inherently subject to revisions as new data emerges, especially for non-OECD countries such as China where timely and accurate data is still a scarcity. Major developments affecting economic growth rates are also closely tracked given the potential effect on oil demand while violent political turmoil in oil producing regions continues to have a significant impact on the supply outlook. All these factors will drive the pace of the market realignment underway but the trajectory is set for a more balanced market outlook in 2017.