Will demand-supply imbalance force OPEC to cut crude output?

Oil prices have been on the decline over the final three months of 2018, with a 42% drop in Brent seen from the October peak to December low. Much of this has been associated with forecasts of supply outstripping demand, thus dragging prices lower. However, with the price having started to move higher after falling into the $50 region, traders are keen to gauge whether this is the bottom for the market or not.

The Organisation of Petroleum Exporting Countries (OPEC) monthly report, today, has provided us with an update on the state of affairs for global crude. The decline in crude prices throughout the fourth quarter (Q4) saw OPEC take action in the form of 800,000 barrels per day (bpd) production cut, leaving an additional 400,000 bpd to non-OPEC nations such as Russia. This latest report showed that OPEC production indeed fell by 751,000 bpd; some 94% of the cuts proposed. However, while we saw a significant reduction in OPEC output, the overall global supply reduction came in at 350,000 bpd. That highlights the fact that where OPEC reduces output, the US is often there to step in and replace production to gain market share. Interesting enough, the report also highlights Russia as one of the main drivers of rising 2019 supply, despite OPEC reaching a deal to reduce Russian production.

Supply

On the supply side, the image below highlights the main drivers outside of OPEC, with the US once again the main country to watch. Yes, we are likely to see OPEC continue to ease back on output in a bid to raise prices. However, if we see Russia raise rather than cut production, then the markets will have to align with the fact that the non-OPEC 400,000 bpd non-OPEC cut is unlikely to happen.

The image below highlights the fact that much of the growth in output comes outside of OPEC, highlighting the attractiveness for countries such as Qatar to leave the cartel. US production under US President Donald Trump is likely to continue rising, although crude prices will have an input on the economic viability of projects of operations. Thus, the longer prices remain depressed, the likelier it is that US production starts to wane.

Demand

When looking at the 2019 demand picture, the OPEC report now expects to see demand rise by 1.29 million bpd. That is below the 1.5 million bpd growth seen in 2018, and when comparing with the steady supply growth outside of OPEC, it is clear that there are reasons for such depressed crude prices.

Thus, we know why oil prices have been declining into the depressed levels we see today. However, the gains we have seen over the beginning of 2019 highlight the feeling that something could easily shift to provide a significant reprieve from such weakness. Perhaps US output will decline in the face of lower prices.

Interestingly, we have seen US inventories fall each week since November, while the rig count has been largely flat throughout the second half of 2018. This does not mean that US production is on the cusp of a major reversal, but certainly it does add some hint that the strong expansion in US crude is easing.

Nevertheless, until we see another significant shift in output levels from the likes of Saudi Arabia, Russia or the US, it is likely that crude prices will remain relatively depressed. Near-term price action is going to be significantly influenced by the ability to break through the $63.75 resistance level. A rally through there would signal an end to the downtrend in place since the October high.

However, looking at things from a short-term perspective, it is clear that we could be due another move lower in the coming days. The failure to break through the $62.52 peak could mark the end of this recovery, for now. Looking at price action over the past 24 hours, a drop into the $60.06 swing low highlights the fact that higher lows are no longer in play.

Thus, a break below that level would signal the beginning of a bearish phase for Brent. Whether such a move could break below the previous lows of $50.00 is another matter.