In December 2016 the 14 member states of OPEC and 10 non-OPEC nations decided to cut their production by 1.8 million barrels per day (bpd). Naysayers believed that there would be insufficient discipline and were proven wrong. Compliance even exceeded 100 percent at times.
This announcement resulted in a temporary spike in the oil price of nearly $60 per barrel in January. It then tumbled to the mid-40s in July on the back of Nigeria and Libya producing an unexpected additional 700,000 bpd. The pair had been exempted from the “declaration of cooperation” due to their dicey internal situation.
The rapid increase in production came nonetheless unexpectedly. At the same time shale producers increased their production significantly. They had suffered under low oil prices since 2014 and many companies had gone bankrupt. The surviving entities, however, increased their productivity by 3 percent month on month. Shale came back with a vengeance.
Both OPEC Secretary-General Mohammad Barkindo and Al-Falih had repeatedly warned that a rebalancing of markets would take time. It did, but we are well on the way to achieving this goal.
The first indication was in autumn when the geopolitical risk premium returned to the oil markets. Prices went up when Donald Trump’s refusal to re-certify the Iran nuclear deal spurred fears of renewed sanctions, North Korea fired missiles and the Iraqi army took possession of the oil fields around Kirkuk and put exports to Turkey in doubt.
Another indication was that global oil stocks which serve as an important metric for traders drew significantly: The developed world’s crude oil stocks stood at 360 million barrels above the five-year average at the beginning of 2017 and have come down to 140 million barrels above the five-year average in November.
This development would not have been possible without the co-operation between KSA and Russia, the former taking leadership in OPEC and the latter over the non-OPEC countries. OPEC also started to communicate like a central bank. Their “forward guidance” about quantity was announced in December 2016 and pretty much adhered to.
The Saudi and Russian energy minister have taken a leading role in regulating supply
Al-Falih understood that there cannot be anymore surprises going forward, which is why he and Novak jointly take over the Joint Ministerial monitoring committee (JMMC) in the new year.
Barkindo recently told Bloomberg that he saw markets well on the way to balancing. Al-Falih agreed at the last OPEC meeting, but not without emphasizing that the signatories to the declaration of cooperation needed to remain vigilant.
Russia has been one of the biggest winners of the production cuts. It only needed to reduce its production by 300,000 bpd, which is negligible on a production of around 11 million bpd. Hence they were able to fully benefit from the uplift in price. The exercise was costlier to Saudi Arabia. The country cut the most and in the process lost market share in the important Asian markets. It was replaced by Russia as the biggest supplier of crude in China; and by Iraq in India.
Prices are now comfortably above $60 per barrel for Brent. They even spiked to nearly $66 per barrel earlier this month when the important Forties’ pipeline network need to be shut IN due to a leak.
2018 will see upward and downward pressures on the oil price.
The world economy, especially China, is humming, which always helps demand. We can expect a demand increase of between 1.3 – 1.5 million bpd in the coming year.
There is a big question mark over how much Venezuela can produce while undergoing political and economic turmoil. Iran is another question mark: Whereas renewed sanctions would merely result in redirecting crude from Europe to Asia in the short run, in the longer term the country’s oil sector needs massive investment and access to Western technology.
Finally, the international oil majors have curtailed their scheduled investment programs by as much as 40 percent over the past few years. This will at some stage be felt in their production capacity.
We don’t know how much incremental production we can expect from countries who are not signatories to the declaration of cooperation. Particularly US shale producers could surprise. There is a question mark over how much more the US shale space has to give geologically. The international consultancy Wood Mackenzie expects shale production to double from 4.9 million bpd in 2017 to 9.6 million bpd in 2024 and decline thereafter.
OPEC expects non-OPEC production to increase by around 1 million bpd IN 2018 while the Paris-based International Energy Agency (IEA) thinks the production increase will be more like 1.6 million barrels.
Up to now Russia has been on board and profited handsomely from higher oil prices. There is pressure on Alexander Novak from Russian oil companies to lift the production restrictions: They sit on 23 fields (14 of which belonging to Rosneft) that could significantly add to production. Experts put that number at around 770,000 bpd.
It will be pivotal for OPEC to monitor compliance with the declaration of cooperation, keep Russia on board and monitor the markets very closely in 2018. Vigilance is the order of the day and Both Messrs. Al-Falih & Barkindo have understood that. They have their work cut out for them.
• Cornelia Meyer is a business consultant, macro-economist and energy expert.