The Single Largest Supply Risk In Oil Markets

Venezuela could be the reason that "tips the market decisively into deficit," the International Energy Agency said in a new report.

Venezuela lost another 60,000 barrels per day (bpd) in February, according to the Paris-based energy agency, and continues to present the largest supply risk to the global oil market. The IEA noted that even if Venezuela's production levels hadn't cratered over the past year, and it produced at the agreed upon level as part of the OPEC deal, the group would still be posting close to a 100 percent compliance level. As it stands, however, Venezuela's plummeting output put the cartel's compliance rate closer to 150 percent, the highest figure to date.

Aside from that, the IEA said that not much has materially changed over the past month, but expressed a more bullish outlook towards the market for 2018. Oil inventories happened to climb in January for the first time since July 2017, but only increased by 18 million barrels, or about half of the usual rate for that time of year. In fact, the oil surplus only stood at 50 million barrels, while refined product supplies are actually in a deficit.

The agency slightly revised up its forecast for oil demand for 2018 by 90,000 bpd to 1.5 million barrels per day (mb/d). Demand is particularly strong in China and India. Supply is still expected to grow by 1.3 mb/d in the U.S., a huge figure, but unchanged from previous forecasts. Non-OPEC supply is expected to grow by 1.8 mb/d.

The IEA says that "market re-balancing is clearly moving ahead with key indicators - supply and demand becoming more closely aligned, OECD stocks falling close to average levels, the forward price curve in backwardation at prices that increasingly appear to be sustainable - pointing in that direction." Inventories are expected to see a "very small stock build" in the first quarter, but then decline for the rest of the year. Related: OPEC Deal In Jeopardy As Iran And Saudi Arabia Square Off

That is a decidedly more bullish take - in tone, if not in substance - compared to the agency's report from a month ago, when it warned that history was repeating itself. In February, the IEA said that U.S. shale production was growing so quickly that it could lead to another period of lower prices, spoiling OPEC's effort at re-balancing the market just as that elusive goal appeared "close to hand."

But, assuming OPEC keeps production flat for the remainder of 2018, the threat of an "accelerated decline" from Venezuela could be the "final element that tips the market decisively into deficit," the IEA said. That is an entirely plausible scenario.

One risk factor to this forecast is the possibility of a trade war sparked by U.S. steel and aluminum tariffs. A trade "slowdown would have strong consequences, particularly for fuel used in the maritime sector and in the trucking industry," the IEA warned.

In the medium-term, things look even tighter. New oil discoveries in 2017 hit a record low at only 4 billion barrels, which stands in stark contrast to the 36 billion barrels that were produced. The shockingly low level of new discoveries is the direct result of a dramatic fall in spending on exploration. The problem is that even with oil prices up substantially from a year ago, the IEA only expects investment to increase by 6 percent this year, after remaining flat in 2017.

Surging shale production will paper over this problem for the next two years or so. But after that, as the historic shale expansion slows to more pedestrian levels, "the market might well need the supplies currently being held off the market by leading producers," the IEA said. Related: Is Another Oil Price War Looming?

For OPEC, that might be a long time to wait, and it is unclear if the group can hold onto its production limits until 2020. Nevertheless, beyond 2020, the IEA warns that the makings of a supply crunch are already materializing as there is a dearth of new production from large-scale conventional oil projects in the pipeline.

For now though, we are in a steady wait-and-see mode. The first half of the year is always a seasonally weaker time for the oil market. But the market could tighten later in the year - demand picks up in the summer, Venezuela could post stronger declines as the year wears on, and inventories are expected to tighten. U.S. shale is still expected to post "explosive" growth in 2018, but shale drillers might not swamp the market as some have feared.

By Nick Cunningham of Oilprice.com

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