The year oil went from bust to boom — and back again
Last week was brutal for oil prices. A barrel of Brent ended the week shy of $53, down nearly 40 percent from the highs of early October. Prices gained about $2 in early Asian trading on Monday.
The year was characterized by a bust, boom, and another dramatic bust. We should now ask ourselves three questions: What happened, what is going to happen, and what are the longer-term ramifications?
Three factors brought about the boom-to-bust moments of 2018. Firstly, it took time for the OPEC+ production cuts to take hold at the beginning of the year, as it did for the incremental production increases in the summer. If this year proved one thing though, it was that OPEC+ — which comprises the producer group’s members plus 10 other nations — will deliver on its promises, but that we need to give it the time and space to do so. In this sense, the market is probably underestimating the group’s determination and ability to deliver on the further 1.2 million barrel per day (bpd) production cut agreed in Vienna earlier this month.
Secondly, the shale space never ceased to surprise on the upside. True, there were infrastructure bottlenecks, which hampered growth in the second and third quarters. There again, the US has a very entrepreneurial economy, which reacts quickly to market forces. Shale is among its most entrepreneurial sectors, and issues such as infrastructure bottlenecks tend to get addressed quickly.
Thirdly, the Iran sanctions put a real spanner in the works. OPEC+ members, particularly Saudi Arabia and Russia, were producing at record levels earlier this year, as they anticipated up to 2.5 million bpd being taken out of the market. That looked justified in autumn when Iranian exports fell by nearly 1 million bpd in anticipation of the sanctions. However, in November the US granted eight countries waivers, and suddenly there was too much oil on the market. Prices went from boom to bust in a nanosecond.
Last week’s further slump in oil prices could not be explained by fundamentals, though. The culprit was the stock market. The Dow went negative on the year, reflecting broader market sentiment.
2018 was characterized by a bust, boom, and another dramatic bust. We should now ask ourselves three questions: What happened, what is going to happen, and what are the longer-term ramifications?
This brings us to the outlook for next year: Storm clouds are gathering over the global economy, with forecasts being downgraded due to the fear of trade wars, Brexit, euro zone wobbles and a slowing US economy. All three major oil agencies — the EIA, IEA and OPEC — are watching demand closely. We can expect a further downward revision of demand as the mood music for the global economy is turning more somber.
We also need visibility on how the US administration intends to proceed with the sanctions regime. If it leaves the waivers in place, OPEC+ has calibrated correctly and markets should balance. Yet there is also oil output to consider from Libya, Nigeria and Venezuela — which are unpredictable due to their challenging domestic circumstances.
Taking a longer-term perspective, it has become a home truth that the advent of big US shale production has changed the balance of power in the oil space. This gives validity to the OPEC+ alliance, under which the world’s second- and third-largest producers, Russia and Saudi Arabia, cooperate in a bid to balance oil markets. This mechanism is important because businesses as well as consumers benefit from prices fluctuating in a predictable range.
The energy industry needs that predictability in order to schedule investments. Conventional oil is an ultra-long cycle business, and a dollar invested today will produce a barrel in four to 10 years. The industry needs to get ready now to pump sufficient barrels when shale production is expected to plateau in 2024. We cannot afford a cavalier attitude if we do not want to see the lights go out toward the latter half of the next decade. Therefore, OPEC+ members have vital work to do in balancing the markets.
- Cornelia Meyer is a business consultant, macro-economist and energy expert. Twitter: @MeyerResources