IEEJ：May 2018○ｃIEEJ 2018
Special Bulletin
A Japanese Perspective on the International Energy Landscape (374)

May 7, 2018

WTI Rises Close to $70/bbl for 1st Time since November 2014
Ken Koyama, PhD
Chief Economist, Managing Director
The Institute of Energy Economics, JapanOn May 4, the front-month West Texas Intermediate crude oil futures contract closed at$69.72 per barrel on the New York Mercantile Exchange, up $1.29/bbl from the previous day. It rose
for the third straight day, posting an intraday high of $69.97/bbl, close to the psychological barrier of$70/bbl. The WTI futures last traded above $70/bbl in late November 2014. If the price rises above
the barrier, it would be the first time in 42 months. On the same day, the front-month Brent futures
also gained $1.25/bbl to $74.87/bbl. It was pointed out that the WTI’s rise close to $70/bbl came as
buying outpaced selling on market participants’ growing consciousness of geopolitical risks amid
increasing tensions over the Iran nuclear agreement. In a manner to support the crude oil futures hike,the Dow Jones industrial average on the New York Stock Exchange soared by 332 points or 1.4%
from the previous day to 24,263 on the U.S. unemployment rate’s fall to an 18-year low and famed
investor Warren Buffet’s reported plan to acquire additional Apple shares.
So far this year, crude oil futures prices increased substantially from the 2017 averages of$50.9/bbl for WTI and $54.7/bbl for Brent. In January, Brent rose back above $70/bbl for the firsttime in 37 months. Since April 10, Brent has remained above $70/bbl and WTI has stayed above$65/bbl. The averages for January-April came to $68.4/bbl for Brent and $63.8/bbl for WTI, postinga substantial increase of $12-13/bbl or more than 20% from a year earlier. In this sense, theinternational oil market and crude oil prices may be entering a new phase.
Certainly, geopolitical risks have been combined with robust economic growth and arisk-on market to boost crude oil prices. While these direct factors are important, changes in supply
and demand fundamentals are even more important. The current crude oil price uptrend started inOctober 2017. Since then, the market has grown responsive to geopolitical risks in the Middle East,leading crude oil prices to creep up. While the Organization of the Petroleum Exporting Countries,
Russia and other non-OPEC oil producing countries have continued their coordinated production cut
since the beginning of 2017, private sector oil inventories in the world (or the Organization for
Economic Cooperation and Development) have sustained a decline to gradually reduce excess
inventories. When inventories remained excessive, the market was not responsive to geopoliticalrisks. As inventories have declined close to the normal level, however, the market has grown
responsive to geopolitical risks.
As crude oil prices have risen close to $70/bbl this year, whether the rise is a temporary
one depending on geopolitical risks has attracted global attention. Then, the potential acceleration ofU.S. shale oil production expansion has become a key issue. U.S. shale oil features a short
investment-production cycle and production costs have fallen thanks to the industry’s cost-cutting
efforts in the low oil price period. As investment and production at the current price levels can be
expected to result in sufficient profits, U.S. shale oil production is now forecast to increase
substantially this year. The International Energy Agency has predicted that shale oil production
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expansion would lead U.S. oil production this year to post an increase of 1.52 million barrels per day
from 2017, the largest since a historic rise in 2015. The predicted U.S. oil output expansion alone
would amount to a global oil demand increase of 1.47 million bpd. U.S. oil production growth alonewould thus cover a global demand rise. Given the potential acceleration of U.S. shale oil production
expansion toward the second half of this year, the U.S. oil production growth is expected to restrict
crude oil price hikes.
U.S. shale oil production expansion is certain to impose a grave impact on the global oil
supply-demand balance. In analyzing the recent price hike, however, we must reconsider the whole
picture of the entire supply including U.S. shale oil and of the market. As noted above, global oil
demand in 2018 is rising robustly for the second straight year, driven by demand growth in Asiandeveloping countries such as China and India. On the supply side, non-OPEC oil production thisyear is expected to rise by 1.79 million bpd from the previous year, according to the IEA. Supply
growth is thus expected to surpass demand growth. This means that non-OPEC oil production
growth alone could cover demand growth. The United States is predicted to expand oil production
by 1.52 million bpd, Canada by 250,000 bpd and Brazil by 100,000 bpd. The three countries’ oilproduction expansion thus totals 1.87 million bpd against the forecast global production growth of
1.79 million bpd, meaning that non-OPEC oil producing countries other than the three would reduce
their output even amid crude oil price hikes. Conversely, the supply-demand balance could be very
tight without the substantial U.S. production expansion.
While production in most non-OPEC oil producing countries other than the United Statesis stagnant, some non-OPEC oil producing countries are attracting global attention with substantial
production drops. Among them is Mexico. After maintaining production levels around 3 million bpd
around 2010, Mexico has rapidly reduced production since 2015 due to the maturation and depletionof oil fields and investment shortages. Mexican oil production fell to 2.23 million bpd in 2017 and isexpected to decrease by 150,000 bpd from 2017 to 2.08 million bpd this year. Mexico has attempted
to stop a production decline and increase production by opening the upstream sector to investment.
For the immediate future, however, the attempt would be difficult to carry out successfully. Someexperts say that Mexican oil production fell to 2.09 million bpd in March and is likely to accelerate afall to slip below 2 million bpd. The production drop in such a major oil producing country hasexerted influence on the supply-demand balance, attracting attention from oil market participants.
Even more significant is the influence of OPEC member Venezuela that has accelerated an
oil production decline like Mexico. Due to economic and social unrest, Venezuelan oil production
decreased rapidly to 1.49 million bpd in March from 2.10 million bpd in December 2016 before thecoordinated production cut by OPEC and some non-OPEC oil producing countries. As Venezuelan
oil production is predicted to fall further amid social and economic deterioration, market participants
are sensitive to the Venezuelan situation. The decline in Venezuelan production has led to a drop in
overall OPEC production. In March, the 14 OPEC members’ oil output totaled 31.83 million bpd,
slipping below the oil cartel’s production target of 32.50 million bpd. While the current OPEC
production cut features many OPEC members’ strict compliance with their respective production
quotas, the substantial fall in Venezuelan output has made an unignorable contribution to the overall
OPEC oil production decline. If the latest OPEC production level of 31.83 million bpd is maintained,
demand would exceed supply in 2018 as in 2017, resulting in a further decrease in inventories.
Market players have gradually recognized such situation and grown responsive togeopolitical risks including the Iran problem. In this sense, they will closely watch U.S. President
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Donald Trump’s decision on the Iran nuclear agreement on May 12. If the United States withdraws
from the nuclear agreement, crude oil prices could rise further on concern about the decision’s
impact on Iranian oil exports. As a matter of course, the current oil market also faces downside
factors including the escalating U.S.-China trade dispute’s adverse impact on the world economy andthe potential acceleration of U.S. shale oil production expansion. The market situation could change
depending on how these uncertain factors will work. We will have to keep close watch both on
geopolitical risks and major oil producing countries’ production trends.

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