OPEC may not have a handle on oil prices: Supply leaks spring everywhere
No OPEC country wishes low oil prices, and no one in their right mind wants $120-$140 price peaks, as well, as this could precipitate another oil price crisis.
The wish is to keep things just the way they are, with demand balanced by supply, and that’s exactly what OPEC attempted to do in Vienna last week, with its “back to 100% compliance” agreement.
From the looks of it, it has failed miserably.
With band-aid solutions in place, the road to $140 could be on again even as global oil markets continue to rebalance nicely, with the latest International Energy Agency (IEA) oil market report showing OECD oil storage officially below the five-year average by 1 million barrels.
OPEC agreement rationale
The goal of OPEC and its non-OPEC partners since 2016 has been to drain the surplus and bring the market back into balance. Now, with the market balanced, it would make little sense for them to flood the market.
As such, the agreed upon OPEC increases of 1 million barrels of oil per day (bpd) are intended “to keep inventories towards more normal levels and not push the market into oversupply,” Goldman Sachs said in a note.
Oilprice.com, a prominent industry site said Saudi will have the final say on how much oil is added to the market.
“And with the IPO of Saudi Aramco still scheduled for 2019, there is little chance that Riyadh will preside over another market meltdown. Indeed, any effort to boost production will be aimed at preventing a price spike as more and more barrels go offline around the world,” said Oilprice.com.
Expected oil price behavior for 2018
The road to 2018 oil prices has been fairly predictable.
OPEC’s 2017 agreement to restrict their oil output by 1.8 million bpd, led to crude oil prices rising to $80 per barrel in May 2018 for the first time since 2014.
Now the strategy has shifted.
“Major oil-producing countries – Saudi Arabia and Russia – are now planning to take advantage of rising oil prices by supplying more oil into the markets,” said Forbes.
OPEC’s 1 million bpd of new oil into the markets can only be plugged by countries like Saudi and Russia, as most of the member countries are currently not in a position to ramp up their output immediately.
“Consequently, the overall increase in the OPEC oil supply that will reach the markets is estimated to be around 600,000 bpd,” added Forbes.
Since markets anticipated a higher rise in supply from the cartel, this led to a price increase to $75.5 for Brent, as supply couldn’t meet demand.
Forbes said that once the OPEC supply comes into the market, the surplus in the market will grow, causing the oil prices to decline, and revised its estimate originally based on cuts lasting to 2018 from $70 to $67 for 2018.
Gaping holes in supply
It may be that Forbes may have underestimated the supply gaps in the market.
The Financial Times (FT) said that despite the prospect of an extra 1 million bpd of oil, 2.3 million bpd could be lost through disruptions in Venezuela, Iran and Libya by the end of the year.
Venezuela’s economic and political crisis meant a decrease in output by 700,000 bpd in the past 12 months, helping to drive prices near $80 a barrel last month.
Iran, the third-largest OPEC producer, faces the re-imposition of US sanctions on its oil exports after US President Trump’s administration’s withdrawal from the nuclear deal.
“Meanwhile, OPEC’s Libya’s renewed in-fighting cost it 400,000 bpd of production last week and damaged one of its oil ports,” said FT.
Paul Horsnell Head of Commodities Research at Standard Chartered said there could be a further 1.5 million to 2.3m b/d drop by the end of this year just from those three countries.
“It’s much easier to see prices jumping $10-$15 a barrel than falling by that amount,” Horsnell said.
The IEA calculates spare production capacity as oil that can be pumped within 90 days and sustained for an extended period.
IEA estimated OPEC had nearly 3.5 million bpd in April 2018, with Saudi Arabia accounting for about 60%.
“The kingdom’s energy minister Khalid Al Falih indicated that members of the new deal with spare capacity — predominantly Saudi Arabia, its Gulf allies and Russia — will increase output to make up for those that cannot produce enough,” reported FT.
Saudi Aramco will meet customer demand for its crude after the country’s energy minister cemented a deal to boost global supply, according to the company’s Chief Executive Officer Amin Nasser, reported Bloomberg.
He said that Aramco, which currently pumps 10 million barrels a day, has the capacity to produce 2 million more.
On the road to $140?
According to business intelligence site Seeking Alpha.com, even if Saudi and its GCC allies ramp production to full throttle, the oil market deficit will increase – leaving the oil market precariously low on spare capacity.
“Our analysis shows that Kuwait and UAE’s oil production increase will be offset by declines in Algeria and Angola. Iran’s production lost will be offset by Saudi Arabia. And Venezuela’s production lost will be partially offset by Russia, but a drop to 0.9 million bpd will send the deficit shock to the rest of the world,” said Seeking Alpha.com.
“In our view, this supply/demand forecast indicates that sometime in the next one to two years, oil prices will have to move to a level where serious demand destruction takes place.”
Using the chart Morgan Stanley has created called the “global oil burden,” which measures global oil consumption as a percent of GDP, this indicates that oil prices will have to materially surpass the previous highs in 2011-14 (blue line) in order to start severely dampening oil demand. This would put the oil price forecast in the $140+ range.