Last week, the Brent-WTI spread widened to $11.20 per barrel, the highest level since February 2015. Today, the spread has narrowed to $9.76, but West Texas Intermediate still enjoys a larger discount against Brent than at any time in the previous few years. The Brent-WTI spread measures the difference in price between Brent, the international benchmark for crude oil, and West Texas Intermediate, the American benchmark. A wider spread indicates that WTI is relatively more attractive to buyers on the global oil market, and tends to spur domestic production growth.
The Baker Hughes Rig Count, last updated on October 26, posted an increase of only 1 rig in the United States, moving the total number of active drilling rigs to 1,068, up 159 rigs since the same week last year. Takeaway capacity constraints in the pipeline network serving the Permian Basin are tamping down growth in production in that West Texas region; North Dakota and Montana’s Williston Basin was the only area with a net gain in rigs.
A lack of pipelines moving WTI out of Texas has caused a bit of a buildup in oil stocks stored in Cushing, Oklahoma; the bunching-up of supply before it can get to Houston export facilities—and buyers—created a localized surplus, driving down WTI relative to Brent. This morning the EIA said that U.S. crude inventories rose by 3.2M barrels last week.
We pay attention to American oil production for two reasons. The first is that since the United States has become a major oil producer, high oil prices are no longer a clear net drag on the economy; industrial production and oil and gas exploration can reap major benefits. And hydraulic fracturing, especially when combined with horizontal drilling, is extremely truck-intensive. Check out our new white paper, Fracking, to get a better sense of how frack sites’ demand for sand, water, chemicals, and equipment drive up truckload demand. We estimate that a single fracking site implies demand of at least 3,000 truckloads per year. Transportation companies and shippers are also interested in the price of diesel fuel, which lags crude prices by a week or more.
There remain a few reasons to hope that oil prices may start recovering from the selloff that began on October 3. If yesterday’s equities markets rally can be sustained, oil traders might feel more optimistic on the demand side. Emerging markets, which get a disproportionate amount of energy from fossil fuels like coal, have declined since the beginning of the year. If those countries—including China, Indonesia India, Pakistan, Brazil, Mexico, etc—can’t turn economic growth around in 2019, their troubles could drag down global oil demand and prices.
“The best way to think about emerging markets is in the context of a bigger ongoing regime change,” wrote Mohamed El-Erian, chief economic advisor for Allianz, wrote for Bloomberg. That means “a transition away from ample, consistent and predictable injection of central bank liquidity, and toward a more fundamentals-driven global economy and markets that is being undertaken as the balance of risks is tilted toward the downside.”
In terms of supply, a lot depends on the success of the Trump administration’s efforts to convince China, India, Japan, and Europe to stop buying Iran’s oil on November 4, when the White House’s sanctions will take effect. Those sanctions are expected to remove about 1M barrels per day from the global market by the end of the year. Traders are waiting to see how Saudi Arabia will react; the kingdom’s energy minister Khalid al-Falih has promised that the Saudis can make up the shortfall. Meanwhile, in Venezuela PDVSA continues to deteriorate: Rystad Energy calls for future reductions in crude oil production from mature fields, halving even the current anemic production rate by 2020.
“We forecast some mature fields, such as El Furrial, Tia Juana and Bachaquero, to lose around half of their production in 2018. Overall, we forecast crude production from mature fields to decline 35% y/y in 2018 and 25% y/y in 2019,” Rystad wrote.
In our view, oil prices would be even lower without supply worries related to Venezuela and Iran; stunted growth in emerging markets and the widespread expectation of a gradual slowdown in U.S. GDP growth next year are the two major reasons to believe that demand will not maintain its 2017-8 trajectory through 2019.
“The bullish argument for crude still centres on Iran sanctions which are due to begin in November, and continued output declines from Venezuela,” William O'Loughlin, investment analyst at Rivkin Securities, said to Reuters.
“There are two downward pressures on global oil demand growth,” said IEA chief Fatih Birol in Singapore earlier this week. “One is high oil prices, and in many countries they’re directly related to consumer prices. The second one is global economic growth momentum slowing down.”