As growth in oil supply diminishes and demand growth continues (albeit at a diminished rate), the implied stock change (reserve growth) is declining. Global demand is currently 94.83 mb/d versus supply at 97.07 mb/d (4Q 2015) leaving a supply surplus of about 2.2 mb/d at the end of 2015. OPEC oil production totals are 32.6 mb/d as of January 2016 but grew by 1.7 bb/d in 2015 accounting for the bulk of the surplus. Around ¼ of this daily supply surplus at the end of 2015 has already been accounted for by diminished production and increased consumption in 2016 leaving current supply excesses (February, 2016) in the 1.87 mb/d range, some of which is being taken up by the building of strategic oil reserves. Current OECD reserves are pegged at 66 days supply. Further, demand for oil is projected to grow at 1.6 mb/d for 2016 leaving, other things being equal, little excess supply. By 3Q 2017, global supply and demand should, once again, be in balance. Part of this is being taken up by declines in US production (expected to diminish in 2016 by 0.535 mb/d) as well as declines in UK and other production. Against this, Canada’s output is expected to increase by 0.156 mb/d for 2016. Demand in the US is expected to remain flat for 2016 (but not decline) Demand continues to increase in China, India and the developing economies generally. Supply and demand balance by 3Q 2017 will gradually lead to price increases which should start to be able to be seen by 2Q 2016.
Demand growth in China remains strong (but not as strong as it was). This is because China’s economy remains on a growth path with real GDP growth projected at around 7%. Further, China is continuing to build strategic reserve capacity (fueled by low prices, strategic interests, and the need to find employment for domestic workers displaced by the relative slowdown in the Chinese economy). China is attempting to roughly triple its reserve capacity by 2020 to 550 mbr from current 190 mbr levels. This would offset 90 days of net domestic consumption (demand less supply) in China. China’s current consumption is 11 mb/d against domestic production of 4.5 mb/d leaving a deficit of 6.5 mb/d. While China’s production may be near peak potential levels, even new supply in China will not meet demand projections particularly if China shifts to a more carbon responsible footprint by replacing coal fired electricity production with natural gas. From a Canadian perspective, it is worth noting that Canada’s production is roughly 3.9 mb/d and therefore less than China’s by 0.6 mb/d.
US oil consumption is currently 19.4 mb/d against domestic production of 13.8 mb/d leaving a deficit of about 5.4 mb/d – slightly less than China’s. The US maintains s strategic reserve of 695 mbr - roughly 100 days of net imports and is scheduled to sell-off a total of 58 mbr commencing in 2018 as a cash flow measure. This amount is less than 10% of its reserve and will leave the US with roughly the same strategic reserve as China. Further, sales of US reserves are not expected to commence until oil price stability has been restored. Until then, the US is expected to continue to manage its oil reserves and grow them slightly although the growth in reserves has been less than expected resulting in futures price increases as of March 9, 2016.
Elsewhere, India’s oil demand is about 3.75 mb/d against production of 1 mb/d and India has plans to establish a 5 million metric ton (36.7 mbr) strategic reserve giving it a little more than a 10 day net supply. Russia’s oil production is roughly 10.39 mb/d – about 3 mb/d less than the US but with consumption of around 3 mb/d its exports at over 7 mb/d are a significant contributor to its economy. Russia is obviously better positioned to serve the Chinese and Indian markets than is Canada.
In 2014, roughly ½ of US oil consumption was in finished gasoline (8.9 mb/d). The remainder was in distillate fuel oil (which includes diesel and heating fuel at 4 mb/d) and other uses but only .347 mb/d (less than 5%) was used as petrochemical feedstocks. Globally, about 2/3 of oil is used in transportation of which about 1/3 is used in commercial transportation and is not easily displaced by a shift to electric or alternative fuel vehicles. Further, as the shift to a lower carbon economy occurs, a replacement of coal as a source of electricity production should continue to increase the demand for natural gas. At present, coal accounts for 39% of total global electrical production (with natural gas and oil together representing 27%). In the US, natural gas has recently surpassed coal as the primary source of electrical power generation. This would seem to be partially driven by price and partially driven by environmental considerations as natural gas is a cleaner source of electricity.
The bottom lines are:
1. Global oil and gas demand are expected to continue to increase
2. The US is reducing production
3. Canadian production is expected to increase
4. Current excess supply is projected to be in balance by 2017
5. Environmental concerns work both in the direction of increasing demand for natural gas (at the expense of coal) and reducing demand for petroleum (in preference for electricity)
6. It is, therefore, too early to count oil out of the picture. The key, as always, will be access to markets of which China and India remain strong. Further, over shorter distances (not overseas), new pipeline technologies may prove to be better alternatives than current shipment of oil by rail.
7. Oil will rebound by 2017. Unless new production comes on line, anticipatory price increases should begin to emerge as early as 2Q 2016 rising above $42 US and settling in around $45-48 US. There will be a temporary price shock in 3Q 2017 as the US prepares to sell some strategic reserves. This will be short-lived as the amounts are trivial and will be used to pay down US debt. Following this, increases to $60-80 US are likely to 2020.
Integrated Analytics & Research Ltd.
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