OPEC, the oil producers' group, must be puzzling over how to crack the current supply conundrum. Their five-month-old market share strategy has not yet humbled the upstart American shale oil producers.
The world still has more than enough supplies. And prices seem to have settled into a durable range, without ever collapsing to US$20 (S$26.96) a barrel as the doomsday forecasters held or not even hitting the bottom reached in the wake of the financial crisis seven years ago.
The benchmark Brent has swung in a US$43-70 per barrel range since the recovery began in January from a 60 per cent fall over six months. Recently, the benchmark nudged the November level when the Organisation of the Petroleum Exporting Countries (Opec) declared its hands-off market policy. The policy will also thwart fresh investment elsewhere, paving the way to higher prices in the future.
Evidently speculators and hedge funds have amplified the price swings since. The US dollar, weakened by delayed interest hike prospects, has also propelled it.
Geopolitics continues to lend markets much strength, lately with a conflict in Yemen. Yet, market anxieties about its Bab-el-Mandeb strait, through which about five million barrels of oil transit daily, are probably overdone. Yemen's external actors have a great self-interest in protecting that strait. Nor would they want to court global wrath obstructing an international waterway.
The crucial price driver, however, is the missing demand. The Chinese economy remains weak and Europe is listless. US growth has slowed. Some of China's purchase has been to fill storage tanks, and India plans to start soon.
Opec had probably hoped the encounter with its rivals loaded in debt to be brief. But the group must press on with the strategy at the June review meeting. Though the weak and populous nations may resist, the big producers should have their way.
Saudi Arabia has claimed that the current strategy is succeeding. Even so, prices are a long way off the fiscal breakeven rates most members supposedly require. Those dreams can materialise only if Opec curbs supply sharply and members honour production levels. Alternatively, rapid growth in consumer economies or a major supply disruption must occur. The scenarios look distant, though the last cannot be ruled out.
Supply exceeds demand by about three million barrels per day (bpd). Some conventional oil production is still off the market. Hundreds of shale rigs are out of action, but output remains robust. The nimble ones have deployed better drilling practices, hedging, equity dilution, mergers, job and rig cuts to carry on. Moreover, thousands of wells have been left uncompleted to resume when the price is right.
Meanwhile, scare over storage space has remained just that. US inventories are at an 80-year high. Still, the Energy Information Administration (EIA), the US energy watchdog, believes more space can be found. Similarly, millions of barrels of oil are also stored outside the US. Iran, for instance, has 30 million barrels in tanks and ships.
Demand is expected to pick up by between 1.1 and 1.18 million bpd, according to Western official energy watchdogs and Opec. That is hardly sharp. The oil group expects total demand to be 92.50 million bpd.
The year ahead will likely add 1.3 million bpd, raising demand to 94.58 million bpd and markets should rebalance by the year end, says EIA.It expects US production to increase more than a million barrels and reach 10.6 million bpd by 2020. But surprise is inherent in shale. Its output was expected to reach only about two million bpd through this decade, half what is being pumped now.
Further, Opec can't get the co-operation it is looking for. Shale oil producers risk running afoul of US antitrust laws if they work with the group. Joint action with other conventional producers has often been contemplated during oversupply, but not concluded. In fact, Russia and others have been adding supplies.
Clearly Opec is in a predicament. It can abandon the strategy only at the risk of admitting further loss of its sway. The group's share of global supply has halved since the 1980s when it first resorted to market flooding.
By pressing on, Opec will keep swelling the inventories. Meanwhile those with disrupted production could return. Iran wants to make up for its lost exports quickly once the final nuclear agreement is signed with big powers next month. Libyan output may also gather steam. All producers will want higher revenues, some such as Angola and Venezuela even more. The wealthy Saudis and their neighbours have ethnic causes to fund and a growing population to support.
But firmer prices will bring on more shale as well as conventional oil. Down the road, other countries such as China, Russia and Argentina all could join the shale race.
Clearly the stronger prices producers are looking for are not on the horizon. Opec has just denied it is pessimistic about the price outlook. The Wall Street Journal had reported that a draft paper ahead of next month's meeting saw prices sharply below US$100 per barrel by 2025. In the glory days, it was markedly above that lofty threshold.
Back in the 1980s when the Saudis opened up the spigot, it was to discipline the group's quota-busters. The period coincided with the height of the Cold War. Time and technology have since transformed the situation. The US, then a big importer, is a potential exporter.
Last decade, oil prices rode on purportedly insatiable Chinese demand amid trumpeted fears of a world running out of oil. Shale oil has assuaged those peak oil worries. China's weakened economy and anti-pollution drive have dulled explosive demand growth rates of the past.
Opec thus faces a tough battle. Perhaps it is time to think beyond today's extra barrels, and seasonal peaks and valleys. The dark clouds gathering over fossil fuel use is an even bigger threat.
This article was first published on May 27, 2015.
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