The outlook for the oil market over the coming few years is scary — not because there will be no demand for oil, but because it is becoming extremely hard to predict developments.
Andy Hall, one of the best oil traders at predicting future trends in the market, has sent a letter to his clients this month telling them he cannot continue his business because it is becoming so hard to predict the market based on the fundamentals of supply and demand. Bloomberg reported on Aug. 14 that Hall is shutting down his flagship Astenbeck Master Commodities Fund II Ltd. and plans to return the cash to investors by Aug. 31 as a result.
Hall is like the Organization of the Petroleum Exporting Countries (OPEC) and others who are finding it hard to deal with the new reality of electronic trading systems and algorithms. This new reality is widening the de-link between physical crude and financial markets.
Issues such as shale oil and electrical vehicles are now affecting the demand and supply side of the equation. The recent push to kill combustion engines by Western governments by 2040 prompted the Economist magazine to highlight the issue on the cover of a recent edition.
So is the future really bad for OPEC — and is OPEC ready for it?
OPEC planners have managed to identify 10 challenges in the latest update of its Long-Term Strategy (LTS), which was approved in November 2016 after two years of struggle.
These challenges are: Oil market functioning and stability; economic growth and uncertainties over the potential growth trajectories; the financialization of oil as an asset class; energy and environmental policies at the national and international levels; technological developments; non-OPEC oil supply development; uncertainty over demand for OPEC crude therefore uncertainties on investments; the negotiations processes with multilateral institutions; availability of skilled human resources in OPEC; and enhanced data flow from member countries.
The approval of the LTS itself was a difficult process. That was because of the differences in the views between OPEC members on how to deal with the future. The debate for the LTS took place during the implementation of OPEC’s market-share strategy that was supported by Saudi Arabia starting in November 2014. That centered on the idea of defending OPEC’s share in the market in the long-term, by letting prices go down in the short-term to push out high-cost producers.
Mohammed Al-Madi, the former Saudi OPEC governor, who was one of the biggest advocates of the market-share strategy, disagreed for months with his Iranian counterpart over the need to include the term “production management” in the LTS. But after the departure of Oil Minister Ali Al-Naimi and the appointment of Khalid Al-Falih, OPEC and Saudi Arabia took a different course and the group returned to its traditional role of managing production. The inclusion of that term in the LTS finally means that OPEC will try to manage production in the long-term. This also may signal that OPEC expects supply-side imbalances to remain for longer.
But the future threat to OPEC is not only coming from other producers who can flood the market with high-cost oil that can be cheap with the advances in technology. The demand outlook is also challenging because of environmental policies and the push for renewables. The push for electric cars, however, may not limit the need for energy and the world will still need more electricity for cars — and this might increase the use of coal and natural gas in power plants.
The world needs a secure energy supply but with enmity toward fossil fuel and OPEC, the motives to invest more in producing oil may weaken.
OPEC is aware of the responsibilities on its shoulders and it is investing in oil and gas fields today to meet future demand. Some of its members are already investing heavily in petrochemicals and downstream to diversify income. Yet OPEC needs to think out of the box to meet other threats like abundant future supply, computerized trading, speculation, and pricing issues. Otherwise, it would be hard for OPEC to read the future just as it was for Andy Hall.
• Wael Mahdi is an energy reporter specializing on OPEC and a co-author of “OPEC in a Shale Oil World: Where to Next?” He can be reached on Twitter @waelmahdi