27 December 2016, London — OPEC and non-OPEC oil producers have agreed to reduce their combined output by more than 1.7 million barrels per day for six months from January 2017.
But the agreement contains a provision that it can be extended for a further six months, subject to market conditions.
Oil traders are betting on an extension, with most of the rebalancing of the oil market expected to occur in the second half of 2017.
Storage tanks are expected to remain fairly full throughout the first six months of the year and only start emptying from June.
Brent time spreads, the difference between futures prices for different months, provide an insight into how traders expect stocks to behave.
Brent futures prices remain in a contango through the first half of 2017, reflecting the need to cover the costs of storing and financing large volumes of crude.
But the contango starts to narrow significantly around June and disappears entirely by the end of the northern hemisphere summer.
The current structure of futures prices implies it will no longer be necessary or financially viable to store such large volumes of crude from the third quarter onwards.
The futures price curve contains an expectation about the state of supply, demand and the demand for storing oil.
Like any other forecast, the curve can be wrong. The oil market could rebalance faster or slower than currently expected.
For example, traders expected stocks to start drawing down from the middle of 2016, and instead, they continued to increase.
But the curve does provide the best indication that we have about the expected timescale for rebalancing and stock draws.
The curve implies a modest drawdown in stocks is expected during the first half and then a much faster drawdown in the second. The expectations appear reasonable.
The oil market will start 2017 with a high level of inventories inherited from 2016 thanks to recent increases in production by both OPEC and non-OPEC countries.
And the end of the first quarter and start of the second is traditionally the weakest time of year for crude demand with many refineries doing maintenance after the winter heating season and before the summer driving season.
But by the middle of the year, U.S. refineries will be ramping up crude processing to meet summer driving demand from motorists.
And Saudi Arabia and Iraq will both be increasing the amount of crude burned in their power plants to meet summer demand for electricity and air-conditioning.
Just as importantly, the underlying demand for crude around the world will continue increasing, provided the global economy avoids a recession, helping tighten the market.
The structure of futures prices implies that OPEC and non-OPEC producers will agree to roll over their output curbs in May and June.
Targets may be modified, and compliance with them may weaken as time goes on, but the oil market’s expected shift into a deficit from mid-year implies some degree of production discipline is likely to be maintained.
The principal risks to this forecast are (a) significant non-compliance by OPEC and non-OPEC; (b) a big increase in uncapped Nigerian and Libya production; (c) a global economic slowdown; and (d) a significant increase in U.S. shale production in response to higher prices.
Any of these factors could delay the expected rebalancing yet again. But in their absence, the oil market is expected to move into a significant supply-demand deficit by the middle of 2017 and draw down stocks heavily in the second half.
*John Kemp; Editing: Mark Potter – Reuters