Oil: a return to equilibrium in the oil market?

Having fluctuated between 100 and 120 dollars per barrel since 2011, the oil price adopted a steeply bearish trend from mid-2014 onwards. In early 2016, it hit $30 per barrel before stabilising at 45 - 55 since then.

The reasons for the fall in the price of crude are well recognised, stemming primarily from supply issues. The exploitation of US shale oil benefitted from a constant improvement in extraction techniques, which triggered a surge in drilling. This increase in activity curbed the decline in US oil production which had begun in the mid-1980s … and even inversed the trend. This was particularly the case in 2014, when oil production increased by more than 1.5 million barrels per day and contributed heavily to the growth in global output (Chart 1). The collapse in the oil price has since curbed US oil production however. Nevertheless, the determination of Saudi Arabia and Russia to maintain output at a high level, coupled with the lifting of sanctions against Iran, has prevented the oil market from reaching equilibrium. Stocks have continued to accumulate since 2014 and have reached all-time highs (Chart 2).

The agreement reached in Vienna on 30 November 2016 marks a turning point however. After having maintained production at a high level for a long period in order to squeeze out the US shale oil producers, the other major oil producers, financially weighed down by this strategy, reached an agreement to cut output. This is the first production limitation treaty since Oran in 2008. OPEC members agreed to cut output by 1.2 million barrels per day (MBD) as of 1 January 2017. Furthermore, the scope of the agreement extends beyond OPEC, as eleven countries in total, including the leading global producer Russia, have agreed to participate in rebalancing the oil market, by reducing output by almost 0.6 MBD.

There is clearly still a risk of the agreed quotas being applied. The agreement should nonetheless provide a floor level for the price of oil. The price is unlikely to surge however, as a heavy volume of stocks remains to be resorbed (Chart 3) and a rapid price rise would undoubtedly rekindle oil production in the US!