Now that OPEC+ has shown its hand, the oil market’s attention is turning to a potential smoothening of relations between the US and Iran. The White House yesterday opened the door for the start of a diplomatic roadmap with Tehran as it joined other major world powers in Vienna to discuss a revival of the 2015 nuclear accord. Iran is the single-largest upside supply risk for the oil market. Supply from the sanctioned OPEC nation is making its way to market in increasing volumes in recent months. And needless to say, a diplomatic breakthrough would set the stage for a further increase in Iran’s oil exports in the second half of this year.
Yet judging by yesterday’s price action, the likelihood of this happening in the near term remains low. Brent and WTI finished solidly in positive territory amid a consensus that the path to lifting US sanctions is still long. According to Goldman Sachs, a full recovery in Iranian oil shipments won’t occur until next summer. This will be to the relief of OPEC’s leadership whose biggest fear is not close to becoming reality.
Aside from the delayed prospect of Iranian sanctions relief, bullish sentiment was also given a lift from updated IMF growth forecasts. The Washington-based lender is now forecasting faster-than-expected growth for the global economy this year. According to its latest projections, the world economy will now grow by 6% in 2021, up from January’s estimate of 5.5%. As much as this will help bolster the fragile demand picture, the recovery is expected to be uneven with developed economies accounting for most of the gains.
Returning to the here and now, the state of US oil inventories is taking centre stage. Overnight, the API reported that crude stocks fell by 2.6 million bbls last week. Conversely, gasoline and distillate fuel stockpiles rose by 4.6 million and 2.8 million bbls, respectively. This tale of two stories on the crude and product front has the makings for further price volatility.
The only way is up, but not so high
The OPEC+ decision to ease existing limits on production beginning in May is not expected to jeopardise the oil rebalancing and hence the elevated price backdrop. In other words, the producer alliance will continue to help rivals such as US shale pump more. America’s crude production has stabilised around the psychologically important 11 mbpd threshold following weather-related disruptions in February. That’s still 2 mbpd below lower than its pre-pandemic levels, but above the average for a week earlier and the four-week average for the period ending on March 26. Looking ahead, US crude output should start expanding slowly at first in the current quarter, then accelerating into the second half of the year.
Underpinning these production increases is a recovery in drilling activity. Higher oil prices in recent months have prompted drillers to return to the wellpad. The number of active US oil drilling climbed by 13 to 337 last week, the biggest weekly increase since January 2020, and their highest since April 2020. Meanwhile, a further sign of recovering US upstream activity is rising emissions. US shale drillers are a major contributor to methane emissions, and they therefore provide a useful barometer of upstream activity. Last year when the pandemic hit, methane emissions slumped by as much as 60% as drillers curbed production. Now, as drilling begins to recover, methane emissions in the US shale patch have rebounded to pre-pandemic levels.
Adding to the narrative that the industry is back in growth mode is the latest Dallas Fed Energy Survey. It found that companies active in the shale patch are willing to spend again and production is climbing steadily. Most shale acreage is profitable with WTI at over $50/bbl, therefore current prices ensure US shale supply will continue to recover from its pandemic doldrums. What’s more, in a further boost for the sector, foreign demand for US crude is expected to remain robust. Nowhere is this more apparent than in India. A dramatic surge in US crude inflows has helped the exporter to displace Saudi Arabia for the first time. This buying pattern should persist with Indian refiners actively staying away from Middle Eastern supplies. The government has decided to reduce oil imports from Saudi Arabia by a whopping 36% in May, according to Reuters, after Riyadh hiked its crude prices.
So, US drillers are back to drilling, WTI is comfortably higher than breakeven prices and the crude export outlook is positive. US shale production is on the rise and this will cement the industry’s impressive track record for getting back up to speed quickly. That said, while some shale operators have jumped on the supply bandwagon, others are focusing on reducing debt and increasing shareholder returns rather than adding output. Accordingly, although US crude output is back in expansion territory, the upside will be limited, so much so that it is still forecast to shrink on an annual basis this year. In its latest monthly report, released yesterday, the EIA lowered its 2021 production outlook by 110,000 bpd compared to the estimate from March. The upshot is that US crude output is now expected to fall by 270,000 bpd this year to 11.04 mbpd. The agency also trimmed its forecast for 2022 US crude output to 11.86 mbpd, down from last month’s estimate of 12.02 mbpd. US production is therefore expected to remain below its previous peak of almost 13 mbpd throughout 2021 and 2022. All in all, US shale players may be turning the production dial up but not so high as to threaten OPEC’s rebalancing ambitions.