OPEC Production Cuts and The Long Road To Market Balance

Posted in The Petroleum Truth Report on April 19, 2017

Global oil inventories are falling because of OPEC and non-OPEC production cuts but the road to market balance will be long.

Production cuts have removed approximately 1.8 million barrels per day (mmb/d) of liquids from the world market since November 2016 (Figure 1).

Figure 1. OPEC-NOPEC Have Cut 1.8 mmb/d Liquids Since November 2016. Source: EIA April 2017 STEO, EIA International Data and Labyrinth Consulting Services, Inc.

Saudi Arabia has cut 619 kb/d (35% of total) and the Gulf States Cooperation Council—including Saudi Arabia—has cut 1,159 kb/d (65% of the total). Other significant contributors outside the GCC include Iraq (12%), Russia (12%) and Mexico (9%) (Table 1). Nigeria’s cuts are probably involuntary since it was exempted from the OPEC agreement. Iran and Libya–also exempted–and both increased production.

Table 1. Summary table of OPEC-Non OPEC production cuts, November 2016 through March 2017. Source: EIA April 2017 STEO, EIA International Data and Labyrinth Consulting Services, Inc.

Inventories and The Forward Curve

OECD inventories began falling in July 2016, four months before the OPEC production cuts were finalized. Stock levels have declined approximately 107 mmb according to recently revised EIA STEO data (Figure 2). That includes the January 2017 increase recently noted in the April IEA Oil Market Report.

Figure 2. OECD inventories have fallen more than 100 million barrels since July 2016. Source: EIA April 2017 STEO and Labyrinth Consulting Services, Inc.

Although this represents progress toward market balance, stocks must fall at least another 260 mmb to reach the 5-year average level to support oil prices in the $70 per barrel range.

Almost three-quarters (73%) of OECD decline was from non-U.S. inventories. Perhaps the intent of OPEC’s November cuts was to stimulate a decrease in U.S. inventories (about 45% of the OECD total). U.S. stocks and comparative inventories were increasing at the time of the cuts and did not start to fall until February 2017 (Figure 3). Since mid-February, U.S. stocks and comparative inventory have each declined 20%.

Figure 3. U.S. Comparative Inventories Have Fallen 20% Since Mid-February 2017. Source: EIA and Labyrinth Consulting Services, Inc.

Still, U.S. inventories must fall another ~150 mmb to reach the 5-year average (Figure 4).

Figure 4. U.S. Crude Inventories Must Fall ~150 Million Barrels to Reach the 5-Year Average and Higher Oil Prices. Source: EIA and Labyrinth Consulting Services, Inc.

The immediate results of the OPEC cuts were an increase in oil prices and an important change in the term structure of crude oil futures contracts. Before the cuts were announced, the term structure of the WTI oil futures curve was in contango (prices are higher in the near-future). That favored storing rather than selling oil and contributed to growing inventory levels (Figure 5).

Figure 5. The Term Structure of WTI Futures Contracts Changed From Contango To Backwardation After the OPEC Production Cut in Late November 2016. Source: CME and Labyrinth Consulting Services, Inc.

In early March 2017, however, oil prices fell as investors lost confidence that the cuts were working. Forward curves moved into weak backwardation (prices are lower in the near-future). Now, prices have increased with outages in Canada and Libya, and the forward curve has moved into stronger backwardation. That favors selling rather than storing crude oil and contributes to decreasing inventory levels.

Market Balance, Supply and Demand

The latest IEA  Oil Market Report stated, “It can be argued confidently that the market is already very close to balance.” What does that mean?

Market balance means that production and consumption are approximately equal. That is an important first step for a market in which production has exceeded consumption for most of the last 3 years but it hardly means that $70 oil prices are around the corner.

Market balance must be expanded to be useful:  production is not the same as supply, and consumption is not the same as demand. Supply is production plus inventory. Demand is the quantity of oil the market is willing to buy at a certain price–it may be either more or less than production.

Oil prices collapsed in 2014 because demand wasn’t great enough at $100 per barrel to absorb the output from the 2010-2014 production bubble. Prices collapsed to $30 per barrel before a transformed market began a weak and uneven recovery, and production surpluses began to decrease slowly (Figure 6).

Figure 6. Critical Supply & Demand Are In Approximate Balance. Source: EIA April 2017 STEO, IEA OMR, OPEC MOMR and Labyrinth Consulting Services, Inc.

Demand did not increase enough until July 2016 to require critical supply withdrawals from inventory–a small subset of total supply. U.S. inventories did not begin to decline until after the OPEC cuts took effect in February 2017.

In the real world, the 5-year average inventory level represents a dynamic proxy for market balance. Comparative inventory is the measure of how far the present market must rise or fall to reach that level. IEA data indicates that inventories are 330 mmb above the 5-year average although revised EIA data suggests that levels are closer to 260 mmb higher than that important benchmark. In either case, it will take 6 months to a year to approach the 5-year average.

Demand Growth

Weakening demand growth is the potential barrier to continued inventory reduction and price recovery assuming that OPEC production cuts hold and are extended. Annual demand growth has declined to 1.25 mmb/d from the comparatively robust 2 mmb/d growth in 2015 and 1.62 mmb/d in 2016 (Figure 7). IEA forecasts continued weak demand growth for 2017.

Figure 7. 2017 Demand Growth Has Fallen To 1.25 mmb/d. Source: EIA April 2017 STEO, IEA OMR, OPEC MOMR and Labyrinth Consulting Services, Inc.

The problem, of course, is that demand is highly price-sensitive in a global economy that is burdened by unmanageable debt. Demand lags price and demand growth reflects the full spectrum of economic headwinds.  In early 2016, oil prices reached the lowest level in a decade-and-a-half. After that, year-over-year demand and oil prices increased through November 2016 and yet, demand growth in 2016 was lower than in 2015. Since then, $45 to $55 per barrel prices appear to have depressed demand growth to annual levels of about 1.25 mmb/d.

The OPEC cuts are accelerating the reduction of global inventories but continued progress toward the 5-year average will push oil prices higher. Higher prices may collide with weak demand growth in a stagnant economy that simply needs less oil. The long road to market balance may be slower and less predictable than bullish analysts predict.


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10 comments on this entry

  1. Thank you for another great article on understanding the possibilities of the future price of oil. The increase in the number of drilling rigs in the US and the resulting increase in production, indicates that the supply-demand balance will not be reached as soon as many are hoping for and $70/bbl oil is likely to be further in the future than producers current plans.

  2. But the 5 year average hasn’t really been a shortage, so looks to me like pressure remains to keep prices from floating back much over $80 for a long time??? Right?

  3. Terrell,

    When inventories are near the 5-year average, prices are high and vice versa.


    It will take quite awhile to get near enough to the 5-year average for me to think about $80 oil prices and there is no reason to expect that prices will even get that high if we reach the 5-year average. Things are clearly different than before 2014.

    All the best,


  4. It looks as though we need a new way to value oil. Some sort of equivalent energy marker, perhaps based on the energy value of human labor?

    Existing currencies all fail to convey the message.

  5. Art,

    Great work on another interesting piece. If they make an Art Berman t-shirt show me where to buy.

    Quick question. I’ve been reading about Iran dumping presanction floating storage and possibly using it as faux production. Think it was around 75mb, either way it’s now gone. Any thoughts to a possible impending upcoming cliff in inventories reductions. Seems this is on the way here shortly as floating storages dump and run dry with the backwardations. My belief is OPEC wants US balanced last and is maintaining crude storage here while they reduce their own inventories which makes good sense strategically.

    John K.

  6. John,

    No T-shirts so far!

    I found some new information from ClipperData, a commodity research company, that confirms what you heard about imports in general–not sure about Iran specifically.


    All the best,


  7. Thanks. Very useful, timely article.

  8. Could you comment on the definition of “incremental liquids” from Figure 2? Clearly it is showing the opposite trend as crude inventory from Figure 4 since July 2016.

    Are the incremental liquids the sum of crude inventory + refined products inventory + NG (boe) inventory ?


  9. PS,

    Thanks for your questions.

    Incremental OECD inventories are based on all liquids that are included in the EIA/IEA liquids accounting–oil plus refined products. The incremental method that I used takes the minimum value for each data series (U.S. & OECD minus U.S. inventories) and subtracts that value from each series. Incremental is, therefore, relative to that minimum volume that is added back in as “Base.”

    The reason for your confusion is two-fold. First, Figure 2 shows crude oil plus refined products and Figure 4 is crude oil inventories only. Crude oil plus refined products inventories have fallen. Below is a graph showing the latter.


    Figure 2 shows the U.S. portion of OECD inventories above OECD minus U.S. It reflects the decline of the data series underneath it that I mentioned in the text below “Almost three-quarters (73%) of OECD decline was from non-U.S. inventories.”

    The figure below is the same as Figure 2 except I have re-stacked U.S. Inventories and OECD Minus U.S. Inventories so you can see the difference in decline rates.


    Another reason for confusion is that OECD data is reported monthly and U.S. inventory shown in Figure 4 and the first image above is reported weekly so there is some difference from averaging. Also, I use a select basket of refined products in my inventory and comparative inventory that is somewhat different from total liquids.

    It is confusing!

    All the best,


  10. Art

    The article and its knowledge surpass my understanding, because my technical level is not so great. But when you talk about inventories it includes biofuels. What is the point of equilibrium for these? I suppose it must be greater than that of conventional and non-conventional oil. Has the production of these been cut?

    A greeting for you and for all who participate and I read to all although I struggle to understand some things