Analyst reviews oil price scenarios ahead of OPEC meeting

May 24, 2017
OPEC faces a tricky balancing act in how it can best reintroduce its supply to the market without risking oversupply and a sharp fall in oil price.  

Offshore staff

EDINBURGH, HOUSTON, and SINGAPORE-In November 2016, OPEC reversed course on its market-share strategy and agreed, with the support of additional non-OPEC producers, to cut output and support higher oil prices. After six months - and a dramatic recovery in US onshore production - OPEC is meeting in Vienna tomorrow, May 25, to announce whether production restraint will continue — and for how long.

OPEC faces a tricky balancing act in how it can best reintroduce itssupply to the market without risking oversupply and a sharp fall in oil price. Wood Mackenzie’s oil-price experts examine four options for OPEC as it meets in Vienna, identifying the situation it feels could be the most likely.  

In January 2017,Wood Mackenzie argued that OPEC would roll over its agreement through the second half of the year. On that basis, the firm forecasted that Brent would average $55/bbl this year.  Wood Mac analyzed 2018 on the basis of no production cuts next year. The annual average price for Brent was forecast at $50/bbl on this basis because, as the chart shows, total oil supply would grow 2.4 MMbbl/d in 2018 compared with world oil demand growth of 1.2 MMbbl/d year-on-year in 2018. 

If OPEC stops trying to support oil prices and seeks market share instead, the analyst wrote that it would see OPEC and Russian production start to rise in the second half of 2017 and continue to increase next year. This would put significant pressure on prices which could fall to an annual average of $43 per barrel for Brent in 2018. While Wood Mac said it does not believe this outcome likely, examining the risk of it highlights the significance of the current agreement to the market.

In the run-up to the meeting, some members within OPEC briefly considered the option of deeper cuts on top of the production restraint already in place. The benefit would be a larger implied stock draw in the third quarter of 2017 than the analyst currently forecasts – potentially as much as 1.8 MMbbl/d, helping to clear current oversupply. This would lead to higherprices in the second half of this year – with Brent forecast to rise just above $60/bbl at the end of the year.  

However, OPEC is currently discussing a Saudi-Russia proposal to extend the existing production cut agreement through the first quarter of 2018. To date, this is the most likely outcome from the May 25 meeting, but with negotiations under way, the situation remains fluid, Wood Mac wrote.

A nine-month extension would have little impact on our price forecast for 2017, which is for an annual average of $55 per barrel for Brent. Into 2018, Wood Mac expects Brent would average at least $55/bbl on a monthly basis. With oil prices at or above $55/bbl during 2018, rig additions in all tight oil plays would be higher than in the firm’s base case.

For a year-on-year comparison, US production would rise 0.95 MMbbl/d in 2018 or 150,000 b/d higher than if the rollover was only extended for six months through the second half of this year. The rate of US production growth in the second half of 2018 would be the fastest seen since the recovery started with consecutive months of 100,000+ b/d of growth.

Finally, OPEC could also extend the existing agreement through the whole of 2018. Although this scenario would have little effect on our near-term base case, it would lead to a tighter supply/demand balance through 2018. The annual average for Brent in 2018 could be as high as $63/bbl. Prices holding above $60/bbl means stronger investment in almost all US tight oil plays.

Finally, Wood Mac said, the trajectory of its rig forecast in this case suggests annual growth rates of over 1 million bbl/d are easily achievable in 2019-2021.