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Rally in oil prices: defensible? -
Rally in oil prices: defensible?
CD Equisearch Pvt Ltd | Published: 09 Nov, 2017  | Source :

The oil producers' meeting in Vienna on 30 November 2017 will be crucial in shaping decision on oil output and thereby the future outlook of oil prices. As per the forecasts of IEA, three quarters out of four in 2018 will be roughly balanced, using an assumption of unchanged OPEC production at 32.7 mb/d, and based on normal weather conditions while 1Q18 imply a stock build of up to 0.8mb/d. As a whole, oil demand and non-OPEC production will grow by roughly the same volume and it is this current outlook that might act as the ceiling for aspirations of higher oil prices in 2018.

Presently, as the cartel and cooperating non-OPEC members discuss yet another extension of the deal—possibly throughout 2018—it looks like they are resolute to have a strategy for a gradual return of production to rebalance and stabilize the oil market. OPEC and the Russia-led alliance of non-OPEC producers are taking 1.8 million bpd of oil off the market, and a near-instant return of supplies would hurt oil prices and inventory levels, regardless of when it happens. In addition to the talks about extending the production cuts beyond March next year, OPEC is now holding preliminary discussions on an exit strategy to gradually return production to the market according to Bloomberg.

The oil industry is showcasing prospects of what seemed unthinkable even a few weeks ago: the prospect of crude trading above $70 a barrel before the end of 2017. Brent crude hit a two-year high of $64.05 a barrel on 6th November, 2017 taking gains to more than 40 percent since June and defying those who argued that oil would be capped at $60 this year by higher output from the US shale industry.

According to International Energy Agency (IEA), after a 33 percent plunge in 2015-2016, the upstream oil and gas investment has bounced back modestly in 2017. A 53% upswing in US shale investment and resilient spending in large oil producing regions like the Middle East and Russia will drive nominal upstream investment to bounce back by 6% in 2017 (a 3% increase in real terms). Spending is also rising in Mexico following a very successful offshore bid round in 2017. There are diverging trends for upstream capital costs: at a global level, costs are expected to decline for a third consecutive year in 2017, driven mainly by deflation in the offshore sector, although with only 3% decline, the pace of the plunge has slowed down significantly compared to 2015 and 2016. The rapid ramp up of US shale activities has triggered an increase of US shale costs by 16% in 2017 after having almost halved from 2014-16.

The rising price of crude reflects the success of OPEC’s output cuts and booming demand as the world enjoys near-synchronized economic growth. Saudi Arabia — the largest producer in OPEC — is also in focus currently, with the arrests of at least 11 Saudi Arabian princes and dozens of senior officials and businessmen raising tensions in a country responsible for roughly one in every nine crude oil barrels pumped globally. In the US, shale producers whose soaring output and the consequent oversupply helped end the $100 oil era in 2014 appears to have stifled this time, with the number of rigs drilling for crude declining in recent months, as companies focus on boosting profitability. The global oil surplus is beginning to shrink due to stronger-than-expected European and U.S. demand growth, as well as production declines in OPEC and non-OPEC countries, the IEA claimed in September, 2017.

The actual fundamentals are improving—unlike other mini price rallies over the past three years. Inventories continue to decline and are tighter than at any point in years. OPEC seems determined to continue with the market management for another year or so. The equivocal question here is how U.S. shale will respond in the backdrop of the rising oil prices. Consequently, if the US shale increases its supply, it would counteract the OPEC’s market management efforts thereby putting downward pressure on prices.

There are two forces at work in the oil markets today creating a tug of war. On the one hand we have U.S. shale producers on a quest to reach 10 million barrels a day in production amid falling seasonal demand. On the other hand, the perception that the oil glut that has gripped the world over the last few years is coming to an end because of OPEC restraint and increased demand from improving economies.

In its forecast as laid out in Oil 2017 Report, IEA emphasized that more investment is needed in oil production capacity to avoid the risk of a sharp increase in oil prices towards the end of its outlook period, 2022. The oil market today seems remarkably optimistic about this issue, but this feeling might not persist for too long before the realization dawns that unwelcome price pressures might lie ahead.

Over the short term however, expected market management by oil suppliers throughout 2018 along with expectations of strong oil demand growth and concerns over few new sources of supply due to years of underinvestment has prompted some analysts to warn that fear of the glut may turn into fear of a supply crunch in 2018. The increased efficiency and technological innovation resulting from the level of investment in the last decade has created an overcapacity which will be difficult to offset as oil demand from China wanes, prompting some analyst into believing that it is not being taken into account in the contemporary oil price rallies. A lot has been achieved towards stabilizing the oil market, but to build on this success in 2018 will require continued discipline.

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