Since earlier this year, our oil forecasts for 2016 have centered on prices returning to $50 per barrel (bbl), the level we believed would help stabilize U.S. production – a prerequisite to meeting even trend demand growth.
Oil prices are now hovering around this level at the front of the forward curve and are about 10% higher one year forward. And as investors eye the outcome of OPEC’s 30 November meeting in Vienna, we’re offering a look at the thinking behind our 2017 outlook for prices in the low to mid $50s.
Simply put, we expect the market rebalancing witnessed this year to continue, which should help sustain higher prices than the average during 2016. We have not adjusted our production outlook for OPEC members and Russia, despite their attempts to coordinate policy in recent months. We are skeptical that actual output will change significantly, for a variety of reasons. If anything, we view the risks related to OPEC production as symmetric around our 33.35 million barrels per day (b/d) baseline due to the potential for Libya and Nigeria to return.
Our oil forecast framework considers both the long end of the forward curve, anchored by the marginal cost at which supply should be able to grow to meet future demand; and the short end, which applies either a premium or a discount to the long end depending on whether the market has a surplus or a deficit. Taking these factors together, our forecast for 2017 essentially represents a short-term discount to the expected long-term price.
We anchor our long-term (three- to five-year) view for oil prices between $57/bbl and $62/bbl. While admittedly the response of oilfield service costs to an expected increase in energy-directed investment is uncertain, we think this is a range the market will come to accept as one where non-OPEC production would accelerate to meet trend demand growth of roughly 1.1 million b/d.
On the short end, we believe the oil market has essentially rebalanced, as evidenced by the end of nearly two years of persistent global stock builds. While this offers scope for considerably higher prices in 2017, inventories remain elevated, and our baseline view is for relatively modest inventory draws on net over the next 12 to 15 months. We thus expect spot prices to remain at a discount to longer-dated prices, but not to the extremes we saw earlier this year.
Our baseline forecast presumes slightly above-trend demand growth of 1.2 million b/d. We see modest supply growth in non-OPEC countries (led by Russia, Kazakhstan, Brazil and Canada) and a broad stabilization of output declines elsewhere outside of OPEC. In the U.S., we think it will take a few more quarters for production to first stabilize around 8.5 million b/d and then grow.
As for OPEC countries, our baseline pre-Algeria meeting was for OPEC output to fall seasonally in the fourth and first quarters before returning to new highs in the middle of 2017. All told, OPEC production should rise modestly in 2017 compared with 2016, on the order of 300,000 b/d.
Despite OPEC’s clear shift to talking prices up (rather than down, as it had been doing into second-quarter 2016), we remain cautious on changing our production outlook. It’s been nearly seven years since OPEC has agreed on individual country quotas and five years since the last OPEC-wide production guidance; we’d expect much debate about appropriate baselines before members even discuss allocations, particularly with output accelerating further since the Algeria meeting. The obstacles to reaching an agreement thus remain formidable, as do the challenges of imposing and monitoring producer discipline. Moreover, Nigerian and Libyan output are not governed by any central authority and remain a wild card.
Still, we acknowledge that the upcoming OPEC meetings are a source of uncertainty. A variation in OPEC output of 1 million b/d from our baseline forecast (+/- 500 b/d ) could cause our price view to vacillate between $45/bbl and $60/bbl and would have big implications for the shape of the forward curve – and all this assumes continued global economic growth and normal winter weather.
Any way you look at it, the next year in oil markets will, at the very least, be interesting.
Greg Sharenow is a PIMCO portfolio manager focusing on real assets and is a frequent contributor to the PIMCO Blog.