Rebalance of oil markets not straightforward

Sunday 07/08/2016

Oil prices have recovered from around $30 per barrel earlier this year to approxi­mately $50 per barrel, although, lately, the price moved into the lower $40s.

The International Energy Agency (IEA), commented in mid-July, that: “Our underlying message that the market is heading to balance remains on track but the modest fall back in oil prices in recent days to closer to $45 [per barrel] is a reminder that the road ahead is far from smooth.”

The rise of oil prices to $45-$50 per barrel is not a move in a linear direction; there are always bumps on the way. What can be said about the current price recovery is that demand is increasing, particularly in India, replacing the role that China played in the markets during the past decade.

Supply is decreasing, particu­larly from non-OPEC producing countries. The cost of developing non-OPEC unconventional crudes (shale oil, oil sand and very deep offshore oil) was not profitable to produce at low oil prices. New exploration for the unconventional crudes almost ceased and development slowed.

The recent price decline can be attributed to overly optimistic predictions of high US gasoline consumption in the summer. This did not materialise, leading to the weak third-quarter performance.

Crude oil and petroleum products stocks have topped out, pressuring oil prices lower. It was expected that a significant rise in global oil demand would lower stocks levels. The trend has been for small increases of demand. In China, for example, the country that provided the largest rise in annual demand during the past decade, registered demand growth this year of only 130,000 barrels per day (bpd) more than in 2015.

The supply situation gives a mixed picture. Non-OPEC production has declined about 900,000 bpd this year. Canada’s production shortfall was approx­imately 1.4 million bpd because of forest fires in Alberta province that shut down production facilities. Nigeria’s production decreased to 1.6 million bpd, from 2.4 million bpd, due to Niger Delta militias’ attacks on surface facilities. Libya has been suffering from civil war and terrorist attacks. The country’s production continues at around 500,000 bpd, compared to 1.6 million bpd before the revolution ousting dictator Muammar Qaddafi.

The world’s two largest oil producers, Russia and Saudi Arabia, maintained production levels of more than 10 million bpd each. Iraq and Iran have increased production.

The latest IEA figures show that OPEC inventories increased 13.5 million barrels in May, ending the month at a record 3,074 million barrels. Prelimi­nary IEA figures from June suggest that stocks of Organisa­tion for Economic Co-operation and Development (OECD) countries added 900,000 barrels, while global floating storage has reached its highest level since 2009.

The oil in storage is sufficient to meet global demand for two months, without new produc­tion. As long the storage is at record levels, it will take time for prices to recover.

The 2014-16 oil price crash led to a critical investment gap in the global oil industry. Scores of exploration projects have either been stopped or delayed. According to recent reports by major banks, the forecast is for a peak of medium-term oil prices sooner than expected as a supply shortage develops.

Barclay’s Bank, for example, projects oil prices averaging $85 per barrel by 2019 before declin­ing to $78 per barrel in 2021. Barclay’s concluded that falling capital spending has accelerated the pace of production declines at some existing oil fields because the natural rate of declines has not been offset by regular maintenance. Essentially, that means drillers will get less out of wells over the long term.

Projections for end-2016 point to prices of $50-$70 per barrel. This level would allow the unconventional oils to resume production at higher levels.

A new feature of the present oil markets is their ability to take in stride the highly volatile political developments in producer and consumer countries. Terrorist militias have occupied oil fields and export facilities in Libya, Iraq, Syria and Yemen. The Brexit vote had a large effect on Euro­pean currencies and the role of London in international finance. North Sea crudes remained steady following the vote. The role of Brent crude oil, produced in the Scottish part of the North Sea, has not been challenged as an international crude marker.

The markets have also remained calm despite the abortive Turkish coup. Turkey, while not a producing country, is a major hub for the transit of Middle East, Russian and former Soviet Union oil and gas to Europe.