Why balance is an elusive goal for the oil industry
The “price hawks” are gathered around OPEC and the 10 non-OPEC nations who have taken 1.8 million bpd out of the market.
The agreement has been extended twice and will run through 2018. Its success has been remarkable: Between January 2017 and now, the inventory overhang of OECD nations was reduced from 340 million barrels to 52 million barrels above the five-year average — a metric keenly observed by the oil markets.
Suhail Al-Mazrouei, OPEC’s president and UAE energy minister, said in London earlier in the week that the reduction of the inventories overhang was a good success, but that “the job was not yet done.” He does have a point in light of the “explosive growth” in the shale space.
At a petroleum conference in Nigeria, OPEC Secretary-General Mohammed Barkindo talked about the signatories of the OPEC and non-OPEC cooperation working to mutate the agreement into a framework for cooperation beyond 2018. This will be important because it will afford the 24 countries covered under the agreement the means to react to supply overhangs and shortages in a concerted fashion. It is also important in the face of Donald Trump’s ambition for the US to become the dominant energy player.
According to Bloomberg, Saudi Energy Minister Khalid Al-Falih is said to be in favor of keeping some form of supply cuts, even if there are temporary demand overhangs. From the Saudi perspective this makes sense. The implementation of Vision 2030 will be expensive, which means that an oil price that is closer to $70 per barrel is desirable. More importantly, the forward curve will matter greatly to the valuation of Aramco, when it IPOs 5 percent of its equity. Al-Falih needs to keep the pressure on future expectations of the oil price.
As the great and the good of the oil industry gather in London for the Energy Institute’s International Petroleum (IP) Week, the messages are coming fast and furious from all corners of the world. There are basically three camps: The “supply enthusiasts,” the “price hawks” and the “Cassandras.”
Lastly there are the “Cassandras.” They worry about how much more the shale basins have to give geologically. Their argument was supported by a Wood Mackenzie study, which warned that shale production would grow until 2024 and thereafter decline. While the study is certainly pertinent, we should not forget how many times shale production has surprised. Late last year, Donald Trump opened the Arctic National Wildlife Refuge and the US coastline for drilling, which may result in new production down the line.
There is also a big concern that the sector at large cut billions of dollars of scheduled investment when the oil price hit rock bottom between in 2015/2016. This could eventually result in production shortfalls. The “Cassandras” see the danger of future oil prices spikes of close to $90 per barrel.
Observers are confused by such a wide range of opinions. Markets are too, as every statement brings with it a movement of the oil price as the general mood swings between euphoria and depression. We saw the oil price flirt with $70 per barrel at the beginning of the month, market turmoil and the IEA report brought it down to $62 and Barkindo’s statement in Nigeria brought it back into the $65 range.
All of this is the reflection of two things: Markets are rebalancing and there is a new giant hitting global markets.
OECD stocks are closer to balance than they have been in a very long time. Markets are uneasy. They do not quite know what a balanced oil market would bring. They oscillate between the fear of a supply or a demand overhang. They remember well the supply shortages in 2007/2008 and what it did to the oil price and to global growth. They also remember the recent past of ultra-low oil prices. This sort of anxiety only happens when we are at the knife’s edge of balance, which is an elusive and always temporary state in any market.
The new energy powerhouse, the US, will have an impact on oil markets. It will not displace the importance of KSA or Russia, especially not in the light of their collaboration. It will, however, affect trade patterns.
The first shale revolution redirected many cargoes from Africa and the Middle East away from the US toward Asia. The second shale revolution means US oil hitting the international markets. (The first US cargo reached the UAE last November.)
While global demand grows, there are enough eager customers to go around. However, the destination of cargos will undergo realignment. Expect the Asian markets to be hotly contested.
- Cornelia Meyer is a business consultant, macro-economist and energy expert. Twitter: @MeyerResources