Global demand for oil has firmly eclipsed supplies in the first quarter of 2017, according to the latest data, showing progress in OPEC’s efforts to rebalance oil markets, and reversing the weaker fundamentals that pressured prices lower from 2014-16. However, oil prices remain volatile, nonetheless, as traders continue to worry that resurgent shale oil production will offset lower production by OPEC and some non-OPEC countries.

Oil prices plummeted in mid-March and reversed almost all of the 20 percent increase since the joint agreement to reduce production by OPEC and some non-OPEC countries was formalized in early December 2016. Oil prices have been pressured lower by both rising shale oil output and stock levels in the United States as well as uncertainty over whether the producer group would extend its new lower output target levels, beyond the initial six months agreed, to the end of the year.

OPEC quickly moved to manage market expectations with Gulf oil ministers and OPEC officials confirming during an industry gathering in Abu Dhabi on April 19 that the agreement would almost certainly be extended for all of 2017 at the May 25 ministerial meeting in Vienna. Prices briefly spiked higher after Washington launched a missile strike on April 6 on a Syrian air base in retaliation for a chemical weapons attack on civilians, but turned lower once again as tensions eased. Following OPEC’s affirmation that an extension of the agreement was expected in May, oil prices gained about $2.50 per barrel (bbl) above their three-month lows in mid-March but remain weak relative to the much stronger levels posted from December 2016 to mid-March. U.S. West Texas Intermediate was last trading at $49.50/bbl and international benchmark Brent crude around $51.60/bbl.

Despite the recent short-term weakness, a number of investment banks see a much more bullish market for the rest of 2017, arguing fundamentals are strengthening, with prices forecast to rise to $56-60/bbl on stronger demand growth and reduced supplies.

Market Rebalancing Underway

The earlier than expected recovery in tight oil production in the United States this year is undoubtedly slowing the rebalancing of oversupplied markets and frustrating OPEC’s strategy to accelerate a drawdown in the massive inventory of oil stocks that have weighed heavily on markets. However, while the pace of the recovery is slower than initial expectations, the rebalancing is unmistakably underway, according to the latest data from the major forecasting agencies. Global oil demand growth is forecast to average 97.9 million barrels per day (mb/d) in 2017, an increase of 1.3 mb/d, according to the International Energy Agency. Global oil supplies are projected to post a marginal decline to an average 97 mb/d this year, assuming OPEC maintains reduced production levels and allowing for an increase in non-OPEC supplies of 500,000 barrels per day (kb/d). In its April oil market report, the IEA reported demand exceeded supply in the first quarter of 2017 and the trend is expected to accelerate throughout the year.

On a quarter to quarter basis, demand is poised to increase by almost 900 kb/d in the second quarter following the steep 1.1 mb/d decline during the traditionally weaker first three months of the year. Quarterly demand is projected to rise by a further 1.1 mb/d in the third quarter before easing to an increase of just over 500 kb/d in the final three months of the year. As a result, the decline in global stock levels is forecast to accelerate on a quarterly basis throughout the year. The latest projections show global inventories were drawn down by 250 kb/d in the first quarter with a much steeper decline of 1 mb/d expected for the second quarter. Assuming OPEC extends its agreement for the full year, oil inventories are forecast to decline by a further 1.1 mb/d in the third quarter and 1.5 mb/d in the fourth quarter.

Global oil inventories are currently just above 3 billion barrels, about 300 million barrels above the five-year average of 2.7 billion. Global oil stocks are forecast to decline by 350 million barrels by the end of the year, bringing them in line with the 5-year average. The latest projections must be viewed with the usual caveats, with both demand and supply subject to revisions given prevailing economic conditions and oil price levels. If history is any guide, the market outlook may be more robust than current data suggest. The IEA has consistently revised global oil demand higher on an annual basis by an average 900 kb/d, according to recent analysis.

U.S. Shale Outlook Menacing OPEC

Market attention, however, currently remains squarely focused on the outlook for global supplies, and especially the fast-paced recovery of shale oil production. Market angst has been sustained by steady increases in U.S. drilling activity and shale oil production following the OPEC-fueled increase in prices since late 2016. U.S. Energy Information Administration (EIA) data for the seven most prolific tight oil regions shows production is on track to increase almost 450 kb/d in May to 5.2 mb/d from a December 2016 low of 4.75 mb/d. Drilling rig activity has accelerated since OPEC reached its agreement in November 2016, rising by a steep 275 to 857 by the third week of April and has more than doubled since April 2016, according to Baker Hughes.

The sharper than expected rebound in rig activity combined with increased capital expenditures and improved well productivity have led to steady upward revisions in U.S. production in April, according to the EIA. Output in the lower-48 states, excluding offshore drilling in the Gulf of Mexico, is forecast to climb by around 750 kb/d over the year, reaching 7.3 mb/d by December. The EIA has made significant upward revisions over the past 12 months for its December 2017 data point, increasing its projections by a staggering 1.6 mb/d, or 30 percent, since April 2016.

OPEC Production Edges Below Quota

OPEC cut output levels to below its new reduced supply targets, declining by 160 kb/d to 31.9 mb/d in March, according to the OPEC Secretariat’s April oil market report. The lower production levels in part reflected supply disruptions in war-torn Libya, according to the Secretariat’s survey of secondary sources. In direct communication to the Secretariat, Saudi Arabia also reported production declined by around 100 kb/d to 9.9 mb/d in March. Overall the group posted compliance of 104 percent in March, according to the IEA, with steeper cuts by Saudi Arabia offsetting weaker compliance by some other members, especially Venezuela, which is only around 40 percent compliant with its new quota target.

Compliance with new targets also improved for non-OPEC producers in March, which the IEA estimates at around 65 percent compared with just under 40 percent in February. The group of 11 countries reduced supplies by 360 kb/d in March compared with their pledged 560 kb/d. Russia reduced supplies by 175 kb/d of its agreed 300 kb/d in March but promised to reach its target supply of 300 kb/d by the end of April, the IEA reported.

Despite OPEC’s best efforts to rebalance markets, however, oil prices are expected to remain volatile leading up to the May 25 ministerial meeting. Early indications that OPEC will extend its six-month agreement are, for now, failing to inspire market confidence and calm fears over resurgent shale. Saudi Arabia’s Minister of Energy, Industry, and Mineral Resources Khalid al-Falih’s comments that a preliminary agreement to extend the cuts had been reached among key Gulf producers on April 20 tempered the downturn but prices may continue to drift lower until a formal agreement is announced in Vienna. A sustained recovery in price levels may not take hold until the second half of the year, when demand strengthens further and a visible decline in global oil inventories emerges.