Cutting Production Does Not Resolve the Oil Glut

At the end of December, crude oil commercial stockpiles for the 34-member Organization for Economic Cooperation and Development (OECD) nations had topped 3 billion barrels. At current production rates, that’s about one month’s pumping, and at current consumption rates that’s a little over one month’s consumption. Production outstrips consumption by around 2 million barrels a day, according to the OECD’s energy arm, the International Energy Agency (IEA).

If producing nations can agree to a production cap at January 2016 levels, as many oil traders and producers hope, the IEA has forecast that stockpiles will continue to build until the end of 2017, even if demand rises. Once the market rebalances supply and demand, there is still going to be more than 3 billion barrels of oil in storage tanks that will take years to clear.

An oil market analyst at Societe Generale told Bloomberg News:

We may get to the end of the year, and even though supply and demand are in balance, the market shrugs and says ‘So what?’ because it’s waiting for proof of inventory draw-downs. Moving from stock-builds to balance might not be enough.

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A Goldman Sachs analyst agrees:

The market will have a hard time trading higher once supply and demand shift into a deficit as the inventory overhang will likely act as a drag until stock levels are normalized.

The IEA expects non-OPEC production to fall by 600,000 barrels a day in 2016 and global demand to rise by about twice that amount. The IEA also noted:

On the assumption – perhaps optimistic – that OPEC crude production is flat at 32.7 mb/d in Q116 there is an implied stock build of 2 mb/d followed by a 1.5 mb/d build in Q216. Supply and demand data for the second half of the year suggests more stock building, this time by 0.3 mb/d. If these numbers prove to be accurate, and with the market already awash in oil, it is very hard to see how oil prices can rise significantly in the short term.  In these conditions the short term risk to the downside has increased.

The IEA forecasts global demand to reach 100.5 million barrels a day in 2020, while global supply will reach 99.5 million barrels a day. Demand is forecast to exceed supply by 400,000 barrels a day in 2018 and 700,000 barrels a day in 2019.