Opinion Piece : A topsy-turvy ride to oil prices recovery to continue

Opinion Piece : A topsy-turvy ride to oil prices recovery to continue

Year 2016 has witnessed some of the landmark decisions in the oil market, which has reversed the trend of oil disagreements within the OPEC and non-OPEC countries, helping rebalancing of the oil markets. The oil price drop since mid-June 2014 was the result of oil oversupply even during passive demands, particularly from Europe and China, wherein Saudi Arabia led OPEC changed its oil policy to grab greater market share. This policy change was largely targeted towards ever increasing market share of the U.S. shale oil companies. However, in their failed attempt to thwart U.S. shale oil business, OPEC countries started to feel the heat and Saudi Arabia faced record budget deficit estimated at $87 billion in 2016.

Therefore, in a bid to support its ailing finances and more importantly to provide profitable environment for upcoming initial public offerings (IPO) of Saudi Aramco, Saudi Arabia once again decided to cut oil production.

However, this couldn’t have been possible without OPEC member countries and Russia-led non-OPEC countries struck a conciliatory note. They did this under the Algiers Accord and in line with this accord struck a deal in Vienna, first since the financial crisis in 2008. Accordingly, 171st Meeting of the Conference of the OPEC decided to implement production target of 32.5 mb/d with effect from January 1, 2017, to accelerate the ongoing drawdown of the stock overhang and striving for the oil market to rebalance.

To strengthen the objective of providing stability in the oil markets, while dealing with oil supply gluts, OPEC member countries further decided to meet with non-OPEC countries in Vienna on December 10, 2016 and sign a global pact between themselves, first since 2001 in Vienna, setting a right tone for the oil markets.

Ever since January 1, 2017, when the deal got implemented, 10 out of 14-members OPEC (now 13 members post withdrawal of membership by Indonesia) have so far achieved around 83 per cent compliance rate with its promised cuts. Their output cut has reached to 840,000 barrels per day (bpd) from their pledged of 1.2 bpd, wherein Russia too curbed its oil production by 117,000 bpd, against promised cut of 300,000 bpd so far.

However, despite the successful compliance rate of OPEC, the road to oil price recovery continues to be a challenging one, particularly after the U.S. President Donald Trump’s pledge to ease drilling restrictions and maximisation of oil production.

Even before the Vienna deal, Obama Administration had already threatened the stronghold of Saudi Arabia led OPEC, questing its ability of swing producing state. Now with shale oil producers being given freehand by Preside Trump increase in oil production will certainly impact the current stock overhang further delaying the rebalancing of the oil markets.

OPEC will therefore, ill afford to ignore the potential risk of emerging oil market scenario being created by Trump, which could weigh negatively into the future creating deep oil supply glut. This could hit hard the revenues of oil producers of the gulf and many other countries besides creating unfavourable platform of lower oil prices to Saudi Aramco for valuation of its IPO, scheduled in 2018.

Even as energy guru and IHS vice chairman, Daniel Yergin, suggests that the worst is over for the oil prices as investments are drying up, the rivalry between the ‘Shale and the Shaikh’ is not yet over, given Trump’s obsession to fossil fuels and his constant denial to climate change concerns.

Furthermore, ever-improving operational efficiency alone has challenged OPEC’s efforts towards rebalancing the oil markets and this will continue in the future as well, given expected rise in global oil prices due to planned production cuts.

Already, the U.S. crude rig counts which hit the bottom with just 316 on May27, 2016, the lowest since the 1940s, have rebounded by around 80 per cent, as on January, 2017 to 566. Oil production of the U.S. too headed north recording 9 mbpd, an increase by 6.3 per cent, since July 2016.

Increased efficiency, lower unit well costs and high-grading since 2014 has helped shale plays of the U.S. to increase their production even during low oil prices scenario. This has helped them to decrease their breakeven prices below $40 a barrel during 2016. Buoyed with such operational advancements in production, the U.S. crude exports is expected to be at 800,000 bpd in 2017, which is almost equivalent to combined production of four OPEC countries, namely, Libya, Qatar, Ecuador and Gabon in December 2016.

Besides, stalled demand from energy guzzling China and every increasing U.S. fuel inventories is set to hit hard OPEC’s ambition to cut oil output. These two factors have already resulted in the fall in Brent and U.S. Western Texas Intermediate crude futures which were trading at $54.54 per barrel, down by 0.9 per cent and $51.52 a barrel, down by 1.3 per cent respectively on February 8, 2017.

Thus, with the compliance of OPEC deal to increase only gradually, relatively sharper increase in the U.S.’s daily oil production will have bearish influence on oil prices.

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