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Demand growth now the focus for oil market

Surging supply threatens to overwhelm balances, unless consumers come to the rescue

The supply side is responding to the recent price rally—and the answer is startling: much more oil is to come. If the market rebalancing is to avoid a reversal through 2018, demand needs to pick up the slack. A buoyant global economy gives it a chance. Oil-price direction for the rest of the year now depends on consumers.

Supply looms over oil futures. US production growth this year and next will be much greater than the bulls expected (and even steeper than many bears thought likely), if the Energy Information Administration's most recent forecast comes good. It expects American crude oil output will average 10.6m barrels a day in 2018, a rise of 1.3m b/d from last year, and jump again to 11.2m b/d in 2019. The juggernaut shows no sign of slowing, as big oil hones in on tight plays. ExxonMobil's pledge to triple output in the Permian by 2025 (to more than 600,000 barrels of oil equivalent a day) is ominous news for anyone still doubting shale's longevity.

It's not just the US. Despite tightening export capacity causing brutal differentials for Alberta's oil sands, Canada's supply will rise again by 280,000 b/d this year, led by Suncor's Fort Hills oil sands project and Exxon's new offshore Hebron development. So will Brazil's, by 170,000 b/d. In its December report, the International Energy Agency expected 1.7m b/d of non-Opec growth in 2018. It will be no surprise if this is adjusted upwards to reflect the US surge. Investment bank Barclays says non-Opec supply growth is returning to 2014 levels. Opec, which forecast just 1.15m b/d of growth, will surely need to catch up too.

Collapsing supply in Venezuela, the possibility of new US sanctions on Iran come May, and Saudi Arabia's insistence that Opec-non-Opec cooperation will continue indefinitely are price supportive. But the Venezuelan descent and Iran are now priced in—the market could be caught out if things don't go as badly as assumed. The Saudi-Russian supply axis also needs to pass through June, when Opec will review the cuts.

Loosening the balance belt

Even if the cuts endure, both the IEA and EIA suggest balances are going to start loosening. The IEA thinks the first half of 2018 will bring a modest stock build, before similarly modest draws in 2H. The EIA says inventories will build by 200,000 b/d this year and next.

So it's up to consumers to hold the fort. Fast growth in the global economy gives them a chance. But the disparity in forecasts is significant. Opec thinks the world will need 230,000 b/d more oil this year than the IEA does (1.53m b/d of growth versus 1.3m b/d). The EIA says demand growth will come in at 1.7m b/d this year and in 2019.

But if oil prices soften a bit in 1H 2018 while the world's economy soars, it's plausible that these numbers will undershoot. The IMF predicts global growth this year of 3.9%, its fastest pace since 2010 (4.3%). That year, consumption rose by more than 2m b/d. Cheaper oil now would help spur that along. The recent rally has lifted Opec's income, but a period of price weakness would be much more helpful if lasting market balance is really the goal.

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