Saudi Arabia faces new oil titan when — and if — it wins battle with U.S. shale

Even if Saudi Arabia wins its struggle with U.S. shale producers over share of the market, it will face a new billion-barrel adversary.

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It won’t be regional nemesis Iran, a resurgent Iraq or long-standing competitor Russia. The solution will be more prosaic: Even when overproduction ends, a stockpile surplus in excess of 1 billion barrels built up since 2014 will stay, weighing on prices. Inventories will keep accumulating until the end of 2017, the International Energy Agency forecasts, and clearing the glut might take years.

“We might arrive at the end of the season, although supply and demand are in balance, the market shrugs and says ‘What exactly?’ because it’s awaiting proof of inventory draw-downs,” said Mike Wittner, head of oil markets at Societe Generale SA in New York. “Moving from stock-builds to balance might not be enough.”

Since it had been unveiled in late 2014, Saudi Arabia’s technique to bring the world’s oversupplied oil markets back to balance by squeezing competitors with lower prices has proved gruelling, dragging crude down to less than US$30 a barrel last month. While a gradual decline in U.S. production signals supply stop growing, the 2nd act of the process may prove a long as stockpiles slowly contract.

For a historical precedent, Goldman Sachs Group Inc. suggests the oil glut that coded in 1998 to 1999 as demand plunged within the wake of the Asian financial crisis. Crude prices kept falling even while the business of Petroleum Exporting Countries made output cuts in March and then June of 1998, slipping below US$10 a barrel in London in December of that year. It wasn’t until stockpiles in developed economies started looking at early 1999 the recovery took shape.

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Between late 2014, when developed-world stockpiles were at about average levels, and the end of the year, global inventories may have swelled by about 1.1 billion barrels, IEA data shows. Another 37 million is going to be put in 2017. Using the agency’s projections based on how quickly inventories will then fall, and estimates from Energy Aspects Ltd. that 290 million barrels will flow into China’s strategic reserves, it will take until 2021 to clear what’s accumulated.

The latest data in the American Petroleum Institute show the build-up within the U.S. is just getting bigger, using the nation’s crude stockpiles ballooning by 9.9 million barrels last week. West Texas Intermediate crude futures fell 2 per cent to $33.70 a barrel a 10:07 a.m. London time.

“For the previous eight quarters to this one, we’ve had global implied stock-builds, so we have accumulated lots of oil,” said Harry Tchilinguirian, head of commodity markets strategy at BNP Paribas SA in London. “It’s likely to have a great deal of time to work out that excess oil in the system.”

Missing barrels

Inventories could erode as early as come july 1st because the decline in U.S. shale output will probably be steeper than is widely assumed, based on Vienna-based consultants JBC Energy GmbH, which predicts prices could rebound to US$50 a barrel in June. A lot of the surplus the IEA estimates accumulated within the fourth quarter of 2015 hasn’t actually appeared in storage, suggesting the surplus is smaller than thought, Standard Chartered PLC says.

“Probably the most likely reason behind a lot of the missing barrels is simply they do not exist” and therefore are the “consequence of underestimation of demand and overestimation of supply,” said Paul Horsnell, head of commodities research at Standard Chartered. “They imply the global market will swing back into deficit prior to consensus.”

Saudi Arabia repeated last week it won’t speed up the re-balancing process by reducing its very own supply. As the kingdom and some other OPEC members have agreed with Russia to freeze output at January levels, a co-ordinated cut is “not happening,” Saudi Oil Minister Ali al-Naimi said at the IHS CERAWeek conference in Houston on Feb. 23.

Inventories began to swell in 2014 because the wave of supply unleashed through the U.S. shale oil boom, along with other new output, outpaced growth in global oil demand by a factor of three. The pile-up continued in 2015 as OPEC members like Saudi Arabia and Iraq raised production to protect their share of world markets. Tanks are poised to fill much more as Iran – freed as of recently from international sanctions – pushes new exports right into a market that’s already saturated.

The time it will take to utilise what’s sitting in tanks around the world contributes to Goldman Sachs’s confidence in the prediction, right now an oil-industry mantra, that prices will remain “lower for extended.”

“The market will have a difficult time trading higher once demand and supply shift into a deficit because the inventory overhang will probably act as a drag until stock levels are normalized,” said Jeff Currie, head of commodities research at Goldman Sachs in New York.

Bloomberg News