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June 6, 2016

Oil Market: Wildfire and Geopolitics with Steady Consumption

A return to an output surplus and cheaper oil is forecasted for as early as 2017 despite disruptions

The global oil market was getting closer to balance in recent weeks by a few temporary disruptions, including the one in the Canadian oil sand production region.While political mayhem in Libya, Nigeria and Venezuela continue to disrupt production and impact the global oil market.

Despite the unexpected deficit in the global oil market, demand for oil is not subsiding and Saudi Arabia, Kuwait, the United Arab Emirates and Russia will continue to help drive supply growth.On top of it, OPEC – the once all-powerful oil cartel – is divided and is having severe difficulty reconstituting as Shiite/Sunni religious divisions tear it further and further apart.

While oil production in Canada's fire-ravaged oil sands area is coming back online, the work stoppage at oil facilities in the Fort McMurray region of Albertareduced Canada's total output by an estimated 1.2 million barrels per day. Over a billion dollars may have been lost in just a few weeks as the facilities begin a “staged” restart.

The wildfire damaged more than just production and oil company profits – it impacted Canada’s GDP this quarter and pushed it into the negative. Current estimates suggest total losses, including oil sale losses in Canada could climb to $9 billion – making this wildfire the costliest natural disaster in Canadian history. And yet, the resulting higher prices per barrel will actually make oil-sand fracking more worthwhile as it costs too much to produce this type of oil to be profitable if oil is under about $48 per barrel.

The wildfires have indeed fueled a surge in oil prices to a seven-month high with prices striking $50 a barrel for the first time since October 2015.The sudden flip from oil output surplus to deficit as well as sustained demand has surprised analysts. Of course, unrest in Nigeria and Libya along withsevere economic issues in Venezuela have caused a loss of nearly four million barrels per day in production.
Overall, oil production was predicated to go down 900,000 barrels a day but because of higher-than-expected volumes from the US, the North Sea, Iraq and Iran the deficit will only be 400,000 per day. Ramped up oil production is still not nearly enough to fulfill Goldman Sachs’s warnings about global storage hitting capacity or of another oil crash that would bring oil to $20 per barrel.

Goldman now cautions that at about $50 per barrel, supply will likely flip-back to a surplus at the start of 2017 – especially if production activity or oil exploration increases as expected.

Demand for oil may or may not be affected, however. Gasoline prices in the US, for instance, dropped along with oil prices in 2014 and consumption did increase but the relationship between prices and consumption is not as clear or correlated as it used to be. In fact, Americans are increasingly driving more than ever before, despite dramatic price fluctuations in the last decade. Vehicles are now more economical and drivers seem to be less concerned with the cost of driving than with the need to commute or travel.

Counter-intuitively, increased consumption may no longer be the determining or significant factor regarding the price of oil per barrel. Although oil reserves are dropping because of all the factors related to a recent decline in supply, the increased oil production from other regions combined with a price per barrel that is conducive to fracking in the US and Canadais enabling consumers to ignore prices altogether. Nevertheless, expectations are high that there will again be a production surplus continue to re-balance the global oil market. Oil reserves may once more approach full capacity but whether oil prices will cyclically decline again remains to be seen.

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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