In recent weeks, renewed trade concerns, slowing oil demand, and a notable acceleration in implied U.S. oil production have spurred a material sell-off in oil. Similar concerns caused oil prices to drop at the end of last year, which prompted OPEC+ (i.e., the Organization of the Petroleum Exporting Countries plus 10 additional oil-producing nations) to cut production, reversing policy set earlier in the year of increasing output ahead of a reintroduction of sanctions on Iran. While OPEC+ output is now near multiyear lows, we do not believe OPEC will abandon the production accord at its upcoming meetings in Vienna (likely in the first week of July) in order to meet revenue targets, given that last year’s experience – boosting output and needing to reverse course soon after – will be informing its decisions. Moreover, actual U.S. oil production may not be as strong as the implied data suggest.
All told, we believe this sell-off is overdone and that the current backdrop offers an attractive opportunity for investors, whether via owning commodities outright or via midstream investments.
Complicated backdrop: trade, production
Oil demand is quite leveraged to global trade and, as such, has lost demand momentum as global trade has faltered. Over the past month, markets have answered the trade tensions and repriced the likelihood of a U.S.–China deal, which in turn may drive some upside to oil demand. However, a recovery in economic activity would likely be a prerequisite for meaningful price appreciation in the near term. Longer term, the upcoming shift in the International Maritime Organization-imposed sulfur cap to 0.5% from 3.5% in waterborne shipping offers a positive catalyst for crude oil demand, particularly light sweet crude.
Another area of uncertainty is the speed of U.S. production growth. Real-time data is limited; the U.S. Department of Energy (DOE) bases weekly production estimates on lagged monthly data, which is subject to revisions long after initial publication. Petroleum economists often augment the lagged production data with an implied production estimate, calculated by including the unidentifiable portion of the oil balances with production. It is this latest string of implied production estimates that we find especially intriguing – and controversial: After largely flatlining during winter months, in part due to weather, U.S. implied production has surged from roughly 12 million b/d (barrels per day) in March to nearly 13 million b/d in May. This rapid increase, if real, would be unprecedented, and (remarkably) would have come just before new pipelines are set to ease the bottleneck in the Permian Basin.
