The oil price has gained 50% since its 12-year low in January. Saudi Arabia and Russia have agreed to freeze oil production and therefore sent out an important signal. Furthermore, oil production has meanwhile begun to fall in the USA.
Consequently, the oversupply on the oil market should have largely vanished in the second half of the year despite higher production in Iran. We still expect a barrel of Brent to cost 50 USD again at the end of the year. The price of Brent oil has climbed by 50% since the end of January and, at 41 USD a barrel, is at its highest level for three months in mid-March.
Is the downward trend now over or could we see a repeat of last year, when the oil price also picked up sharply between February and April and then came under pressure again in the second half of the year (Chart 1)?
The trigger for the current price rally was the agreement in mid-February between Saudi Arabia and Russia to freeze oil production at its January level. Although both countries would probably not have increased their oil production significantly this year even without this agreement, it was still a clear signal that the world’s two biggest producers want to tackle the oversupply.
A resolution on this should be passed on 17 April when 15 OPEC and non-OPEC countries meet again. Moreover, the slump in drilling activity is having more of a visible impact on US production (Chart 2). Production in the USA steadily declined between mid-January and early March and is meanwhile at its lowest in 15 months. Against this backdrop, the current oversupply and the continued rise of US crude oil stocks have not impressed the market.
The US Energy Information Administration forecasts that the daily US crude oil production will fall by 760,000 barrels, which is unlikely to be compensated by other non-OPEC producers. This is a major reason why the International Energy Agency IEA predicts a balanced oil market for the second half of the year. Unlike last year, when it also expected this but the market remained in oversupply all year and global stocks continued to rise, this forecast should materialise this year.
This is because in contrast to last year, US oil production is actually falling in the meantime and OPEC is unlikely to expand its production as sharply as it was still doing last year – also because of the likely decision to freeze production. Although Iran wants to increase its daily oil production to four million barrels, it will only be able to do so in the medium to long term.
We expect Iran’s oil production to rise at a gradual pace of 500,000 barrels a day and the market should be able to cope with this given the fact that global oil demand is still growing. Consequently, the oil price could come under pressure again in the short term as the recent price rise was also speculatively driven. This correction should be limited though. We still expect the price of Brent oil at 50 USD a barrel at the end of the year.