OPEC Oil Supply Cut Target: The Moving Average Will Help
(Bloomberg Gadfly) -- Catching a moving target is difficult, but it's far easier if the target is moving toward you.
OPEC and its associates, which extended their supply cuts on Thursday, are chasing a particularly elusive quarry known as the five-year average of commercial oil inventories in the OECD countries.
This stockpile of oil held by companies (rather than government-controlled strategic stocks) is the most visible indicator of the glut weighing on oil prices and OPEC's progress in draining it.
At the start of the 2017, stocks were 278 million barrels above the five-year average for that month, according to OPEC. As of October, the excess had dropped to 140 million, the group said Thursday. It aims to close that next year, with a review planned for June.
The good news for OPEC is that the average itself will do some of the job.
I wrote here about how the build-up of the oil glut meant five-year moving averages of U.S. inventories were also rising. Like a big meal moving through a python, a sudden increase in stocks will cause a bulge in the moving average for several years.
The same is happening with OECD inventories. Based on OPEC's published data, the implied five-year average stockpile for June 2018 -- meaning the average level for that month in the years 2013 through 2017 -- is 2.853 billion barrels. The implied average for October 2017 is 2.818 billion.
In other words, the average will rise 35 million barrels by the time of the next Vienna show. That means one out of every four barrels OPEC needs to disappear in order to hit its target will be drained not by demand or supply -- just math.
Using the International Energy Agency's figures, and based on preliminary data about stock draws in the U.S., Europe and Japan, it looks like inventories in October were 136 million barrels above the five-year average. Between then and next June, movements in the IEA's average should reduce that by almost 41 million barrels, or 30 percent of the target.
Given how stubborn inventories have proven to be, with OPEC having just extended its initial six-month cut to a potential 24 months, the group will welcome any help, however abstract.
It's still a tough slog, though. While demand has been rising, OECD inventories as of September were still adequate to cover more than 62 days of forward demand, versus the mid-to-high 50s level that prevailed before the crash.
Production from outside of OPEC is expected to continue rising into 2018, outpacing demand growth. This isn't just about U.S. tight oil -- although any effort by OPEC to support prices can't help but do favors for frackers. Earlier this week, Exxon Mobil Corp. started production from its Hebron project, off the coast of Newfoundland, part of a surge in Canadian output expected in 2018. Brazil also should see gains next year.
Estimates vary widely. The chart below shows expected growth in non-OPEC supply less growth in global demand, quarter over quarter, as forecast by the IEA, the U.S. Energy Information Administration, and OPEC:
There's a clear inflection point after the second quarter. OPEC's forecast is clearly the most bullish for the second half of the year, which also helps explain the need for that review in June. However, it's worth noting that this rests largely on much more bullish demand forecasts for the back end of 2018 compared to the IEA and EIA. An even starker difference is that OPEC expects non-OPEC supply to simply not grow at all between the first and third quarters.
The latter, especially, seems a questionable assumption, especially if OPEC's own cuts keep oil prices where are they are now. Saudi Arabia's energy minister indicated on Thursday that enforcement of supply cuts should step up next year and that some struggling members will likely contribute "involuntary cuts" -- a euphemism for the sort of disaster that is engulfing Venezuela right now. Still, only time will tell on this front.
One thing that will happen, no matter what, is that the helpful math of the moving average will start to move the other way. Just as the glut caused the average to bulge, so OPEC's efforts so far to drain the tanks will start to catch up with the average:
Of course, OPEC won't mind the average falling away; it will simply provide proof that its cuts have really had a lasting impact on the glut -- provided, that is, inventories really do keep dropping through the end of next year.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.
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