In the first half of 2017, OPEC and non-OPEC producers agreed to reduce oil output by 1.8m barrels per day (bpd). The move has supported the oil price, but the expected drop in global oil inventories has not materialised. Now, after a calm few months, the oil price has fallen almost 10% to below $50 per barrel, its lowest level since early December 2016.

US Inventories – Supply vs Demand

The main driver appears to be expanding US crude inventories which, according to the API, are rising faster than analysts expected and are now at historically high levels. Data releases from the Energy Information Administration (EIA), a unit of the Department of Energy (DoE) is expected to confirm the rise.

The increased US oil production is partly due to 2016 price increases which have made drilling projects more profitable. US-based shale oil producers have now expanded operations, pushing up oil production to c9.1m bpd (from c8.5m bpd in late 2016). Total US crude oil production was expected to grow by 360k bpd in 2017 and 1m bpd in 2018, putting pressure on the oil price.

Meanwhile, demand growth is sluggish, and expected to remain so over the coming decades, partly due to the development of alternative energy sources – wind is now an established part of the global power supply, with solar gaining in popularity. If large oil producers believe that long-term prices will remain under pressure then, logically, they will look to sell oil stockpiles and assets sooner. This would increase supply further (and push down the oil price).

Shell has announced a deal to sell its Canadian oil business, indicating that it doesn’t see the oil price rising enough to make high-cost heavy oil production attractive. The same logic could impact projects with high drilling costs in other regions, including the UK and Brazil.

OPEC & Non-OPEC Commitments

This market dynamic piles pressure on OPEC (and non-OPEC partners) to extend its output cuts beyond the June deadline. According to analysts, if OPEC extended cuts into the second half of 2017, inventories would likely be drawn down and oil prices recover above $60 by the fourth quarter.

The OPEC group has broadly delivered on its pledged reductions to date, but non-OPEC states have yet to cut fully in line with commitments. Ole Hansen, Saxo Bank’s Head of Commodity Strategy has said that “OPEC has used up most of its arsenal of verbal weapons to support the market. One hundred percent compliance by all is the only tool they have left and on that account they are struggling”

According to Jefferies, “OPEC’s market intervention has not yet resulted in significant visible inventory drawdowns, and the financial markets have lost patience”