Stick With Oil Production Cuts In All Instances

The hopes of those who thought oil prices would shoot over $70 a barrel were dashed as the rally proved to be unsustainable. It did come close to $70 but in a volatile environment the price gradually eased to hover now between $63-$64 for the Brent crude oil marker.

The rally was triggered the expectation of an extension to the Opec and non-Opec production curtailment agreement to end 2018 and then by the actual extension, which was agreed in November 2017 and with the possibility of review in June if market conditions change.

There is no doubt the agreement has done all it was expected and perhaps more. Oil prices recovered from the lows of January 2016 of less than $30 to, as I write, of $63.86. This made a noticeable improvement to the budgets of oil producing countries by reducing their deficits among other things.

The other objective of reducing the oil stocks overhang may not have been completely achieved, but the market is well on its way to reach that target. In January 2016, the oil stocks in the OECD countries were about 380 million barrels above the five-year average level indicator. Now, they are only 52 million barrels above the said average.

Last December, stocks fell by close to 56 million barrels and at this rate, the market is not far from bringing down the level of stocks to, or even below, the target.

Compliance with the agreement has been unprecedented considering the historical experience. The latest report by IEA indicates that Opec members’ compliance is at 98 per cent and that of non-Opec participants at 83 per cent since January 2017 to the present.

A few months ago, the buzzword was about what exit strategy to be adopted by participants in the “Declaration of Cooperation” once the market rebalanced. However, the sentiment has changed to the need of continuing cooperation beyond 2018. At a press conference in Oman in January, the Russian oil minister Alexander Novak said, with reference to his counterpart the Saudi minister Khalid Al Falih, that, “The world’s two biggest oil producing and exporting countries can continue their cooperation for the good of the crude industry, for the good of stability.”

On the fundamentals side, oil demand growth forecasts are still solid, but so are non-Opec supplies, and especially from US shale oil producers. While global oil demand is seen to grow by 1.4 million to 1.6 million barrels a day (mbd) in 2018, non-Opec supplies would more than match this growth and thus leave hardly any room for Opec and its associate producers to increase production.

The IEA is rightly suggesting that “the underlying oil market fundamentals in the early part of 2018 look less supportive for prices.”

There are other uncertainties around what might impact the market. Libyan production, while improving, is not stable. It is a function of two governments, militias and terrorists and without signs of resolution. In Venezuela, the economic and political situation is not improving with an upcoming election near and the threat of US sanctions specifically targeting the oil industry.

The US confrontation with Iran might lead to new sanctions against its oil exports. President Trump is intent on going for a trade war as the announcement to slap harsh tariffs on imported steel and aluminium are expected to have negative implications for commodities.

The Opec Secretary-General Mohammad Barkindo recent meeting with US shale producers in Houston might instill some kind of unofficial understanding. Shale producers are under pressure from shareholders to seek profits rather than production growth, especially as some leading industry figures are less optimistic about future prospects Mark Papa, chairman and CEO of Centennial Resource Development, a pioneer in US shale, warned that “the best days are behind some of those [shale oil] fields after a period of low oil prices prompted drillers to train their rigs on their best acreage and deplete the most cost-efficient production.”

To put it all together, a survey of 15 leading investment banks by the “Wall Street Journal” resulted in the view that “Brent averaging $62 per barrel this year and WTI averaging $58, both forecasts are up $1 per barrel from last month’s results.”

The key for oil producers is to keep their cooperation intact and even in the event of a price escalation, the current production restraint should not be abandoned except in gradual stages to avoid falling oil prices.

The writer is former head of the Energy Studies Department at the Opec Secretariat in Vienna.