Almost nine months after OPEC and its non-OPEC partners implemented production cuts in a bid to rebalance oversupplied markets, tighter supply and demand fundamentals are now supporting prices in a higher $50-55 per barrel (/bbl) range. Global oil prices have ebbed and flowed daily but on a monthly basis have maintained a slow upward trend since June, with international benchmark crude prices trading $8-12/bbl above the 2017 lows.

Against a backdrop of much stronger oil markets, the OPEC and non-OPEC Joint Ministerial Monitoring Committee concluded its September 22 meeting with little fanfare, but noted the alliance had reached its highest ever level of compliance in August at just over 115 percent. The JMMC reportedly discussed the possibility of extending production cuts that expire in March 2018 by an additional three to six months to allow more time for markets to rebalance. Russian Energy Minister Alexander Novak, however, said it was too early to make any decisions on an extension. The next JMMC meeting is scheduled for the day prior to the full ministerial meeting on November 30 in Vienna.

OPEC’s lower production levels since January have had the biggest impact on Asian and European markets, as expected, and led to a corresponding price premium for international benchmark Brent as supplies tightened. Brent futures have increased by an average $8.60/bbl from January to mid-September over annual 2016 levels. The OPEC Basket price, a weighted average of selected crudes from member countries, has posted an even stronger recovery of $9.25/bbl for the same period, which has provided an extra dividend to revenue of some member countries. By contrast, U.S. West Texas Intermediate (WTI) has posted a lower $6/bbl, with rising shale production and swelling inventories weighing on prices. Operational disruptions in the U.S. Gulf Coast oil hub from Hurricane Harvey further tempered price increases. In August and early September Brent was last trading around $56.50/bbl, WTI at $50.65/bbl, and the OPEC Basket at $54.50/bbl.

Oil prices gathered steam in September after latest data from the major forecasting agencies reported stronger than expected global demand growth while supplies fell for the first time in four months in August. The OECD oil inventory surplus to the five-year average is now a significant 45 percent lower than January levels while stocks held in storage in non-OECD countries and at sea also fell sharply. Markets were also buoyed by data showing increased compliance with production targets by both OPEC and non-OPEC countries in August. OPEC curtailed exports to Europe and Asia while Saudi Arabia reduced shipments to the United States, which combined, supported the price recovery.

Fragile Global Oil Balance Going Forward

Global oil supply and demand are largely aligned but latest projections show a modest drawdown in global oil stockpiles in the second half of 2017 will give way to a sharp rise in the first quarter of 2018. OECD oil inventories have declined by almost 150 million barrels since January and are now 190-195 million barrels above the five-year average, according to both the OPEC Secretariat and the International Energy Agency (IEA) monthly oil market reports. That compares with a surplus of around 300 million barrels when OPEC reached its production agreement in November 2016. The “decline,” however, in large part reflects a change in the five-year benchmark, which is adjusted every month since it is a rolling average. In November 2016 the five-year average was 2.7 billion barrels but has since increased to 2.8 billion.

The IEA revised up global oil demand on exceptionally robust growth in OECD countries, by 100,000 barrels per day (kb/d) for both 2017 and 2018. Oil demand is now projected to increase by an average 1.6 million barrels per day (mb/d) to 97.7 mb/d for 2017 and by 1.4 mb/d to 99.1 mb/d for 2018. Oil demand growth surged in the second quarter to 2.3 mb/d, 500 kb/d above forecast. Exceptionally, the United States and Europe account for 80 percent of revision and non-OECD Asia the remainder. U.S. oil demand was extremely robust in the second quarter with lower oil prices driving increased consumption. A combination of stronger than expected economic growth, auto and freight transportation use, and accelerating industrial activity is behind the rise. However, U.S. demand was revised lower for the third quarter due to the disruption in industrial and transportation fuel usage from hurricanes Harvey and Irma. European oil demand strengthened due to an acceleration in industrial production in the first six months of 2017 after a relatively stagnant 2016.

Global Oil Supplies

Global oil production declined for the first time in five months in August due to a combination of unplanned supply disruptions, scheduled summer oil field maintenance, and lower OPEC output. Non-OPEC supply was forecast to rise sharply from July to December but estimates have been lowered in the wake of Hurricane Harvey, with shut-in production projected to be around 250 kb/d for August and September. Non-OPEC supply is now seen rising by 700 kb/d compared to an increase of 500 kb/d in the first half of 2017, according to the IEA. Total non-OPEC supplies are forecast to rise by almost 1.5 mb/d in 2018, with U.S. crude production providing 850 kb/d of the increase.

OPEC crude oil production in August fell 200 kb/d to 32.7 mb/d, largely because of supply disruptions in Libya due to renewed political unrest. As a result, OPEC compliance rose to an average 95 percent from January to August, according to secondary sources reported by OPEC.

OPEC Whistling Past the Graveyard

The current strength in oil prices is surely providing OPEC a welcome respite from the persistent market doubts about its ability to adhere to lower production targets. With just over two months until the first anniversary of their historic production agreement with non-OPEC countries, OPEC officials can ill afford a misstep now. Stronger compliance by Iraq and the United Arab Emirates is needed to increase credibility and rein in supplies further, as long planned non-OPEC projects as well as higher fast-cycle shale start coming online in the next three to six months.

Market skeptics are also keeping a sharp eye on chronic overproducers Iraq and the UAE. Saudi Minister of Energy, Industry, and Mineral Resources Khalid al-Falih has been twisting arms for months to encourage better compliance by the errant producers and, while there was some modest improvement in August, much stronger adherence is needed to convince analysts that the agreement can be maintained in 2018. The UAE traditionally works hand in glove with Saudi Arabia on OPEC issues so its intransigent and flagrant disregard for its new quota has puzzled analysts, with its compliance rate below 70 percent from January to August. UAE Minister of Energy Suhail Mohamed Faraj Al Mazrouei tweeted on August 28 that “In line with the UAE’s OPEC commitments, ADNOC [Abu Dhabi National Oil Company] has informed customers of its crude oil nomination cut for October.” Mazrouei has said the UAE will be a model for OPEC but the market will be looking for much stronger evidence of the country’s commitment to the cuts than just sound bites and tweets ahead of the formal ministerial meeting.

Crucially, Falih steps down as OPEC president at the end of the year and the UAE takes over the job for 2018. Observers will be watching carefully to see if the relentless rounds of shuttle diplomacy that Falih, Novak, and OPEC Secretary General Mohammad Sanusi Barkindo established to maintain cohesion and discipline carry the same clout once the UAE assumes a leadership role, given its credibility issues within the producing alliance.