RBC Warns of Looming Oil Supply Gap As OPEC Mulls Shift in Oil Cut Targets

Tuesday March 13, 2018

The question of whether the Organization of the Petroleum Exporting Countries (OPEC) is close to achieving global supply and demand balance due to its production cuts was raised yet again on Tuesday, with Khalid al Falih, energy minister for Saudi Arabia, quoted as saying it would be better to "overbalance" the market rather than end the cutback deal too early.

Reuters noted that this is "another hint that the pact's expiry could be pushed back."

Falih's comment was in relation to the notion that OECD stocks dropping below the five-year average is more favourable than the swelling of stockpiles that a resumption of full-tilt production - which many OPEC members have signaled is their ultimate intent - would cause.

Reuters also took the opportunity to remind readers that Falih believes OPEC and its partners should look at metrics such as non-OECD inventories, oil in floating storage, and crude in transit, to determine how long the output reduction deal should continue - implying that the metrics used to date are not enough to truly state that the market is close to balance - a claim OPEC has trumpeted for months now.

In theory, this also implies that crude prices are based on extremely shaky numbers as well as sentiment, and one person who is concerned about the effect the price structures will have on fundamentals is Michael Tran, global energy strategist for RBC Capital Markets.

Tran told Bloomberg, "we do think over the course of the year oil prices will likely march to the beat of its own drum - so from that perspective we do believe the backdrop for the oil market is actually looking quite constructive."

However, Tran went on to voice the familiar argument that under investment is leading to a supply gap: he noted that while there is ample liquidity in the front end of the curve, at the fore curve "a lot of the liquidity is dried up; so while you still see prices out to the long term portion of the curve, they're anchored at a very low price," with West Texas Intermediate for 2020 prices at only $52 per barrel.

The problem with this scenario, according to Tran, is "there's not that many companies on a global basis that can make final investment decisions for projects that are long lead time and slightly more expensive in a $52 price environment.

"So we are in this perpetual state of under investment that will lead to a supply gap in coming years."

While the supply gap theory is troubling, the counter argument is that with so many nations dead set on pumping full out regardless of OPEC's intent, the possibility of a gap is questionable: ING Groep NV was the latest body to voice this theory, earlier this week, when it suggested the OPEC cutback deal may soon fall apart.