Are oil inventories really shrinking?

The Organisation of Petroleum Exporting Countries (OPEC) recently said that the global surplus in oil inventories dropped to 130 million barrels above the five-year average in November, down sharply from 154 million barrels the month before.

Mohammad Barkindo said that we are beginning to see a return to stable markets, something that has eluded the market for several years. There are now growing expectations that OPEC will need to offer details of an exit strategy at its June 2018 meeting.

But other industry watchers have a less optimistic outlook. The IEA published a bearish report last week which basically said that US shale would grow so sharply that it would help bring back inventory builds in 2018.

The Paris-based energy agency predicted that non-OPEC supply would grow by 1.6 mb/d, overwhelming demand growth of just 1.3 mb/d. That would put an end to the strong inventory drawdowns that we have seen this year, and the agency predicted that inventories would rise by a rate of 200,000 bpd in the first half of 2016.

The report undercuts the notion that the oil market will reach balance at some point in mid- to late-2018. Meanwhile, OPEC predicts strong inventory declines in the second half of 2018 – a notable difference from the IEA.

Analysts at Oilprice, an oil sector analysis website, indicate that the issues are more nuanced. Citing a study, the analysts said that global finance could curtail fossil fuel investments. A growing number of large financial institutions have pledged to end their support for fossil fuels.

The World Bank has also said that it would no longer finance coal plants beginning in 2019. BNP Paribas said in October that it would no longer lend to shale and oil sands projects. Dutch lender ING said it would cut off finance for upstream oil and gas by 2019. French insurer AXA said it would no longer insure oil sands or coal projects.

This is not to conclude that all categories of investors are shunning the oil and gas sector. Hedge funds and private equity are pouring money into the shale patch despite a growing chorus of investors demanding higher returns from shale companies, according to Reuters. The pressure from investors raised questions about Wall Street’s commitment to the shale industry, but Reuters says that the flow of money has continued to flood in unabated.

It is also important to note that Saudi who cut the most in the supply cap deal, is seeking to ramp up production as its IPO plans take shape. Amin Nasser, CEO of Saudi Aramco’s recently said that the company would regain lost market share once the OPEC deal expires. He also said that Aramco would pursue a large expansion in the downstream sector, with India as one particular place where Aramco wants to expand.

The implication of this development is that oil inventories may not shrink as fast as OPEC thinks. Increasing supply from Nigeria and Libya made the cartel impose cut on their production but oil margins are still too narrow.

Meanwhile, 2018 seems to be critical in the fate of crude inventories. Goldman Sachs predicts that the oil majors are set for huge gains in 2018 after years of underperforming. The investment bank says they will be flush with cash that will be used to send to shareholders in the form of higher dividends and share buybacks. Plus, consolidation in the industry, combined with the oil majors’ unrivalled ability to pursue risky projects, means that they will stand out.

ISAAC ANYAOGU