Supply surplus, weak demand mark oil landscape
Beirut - The price of a barrel of Brent crude oil ended 2015 at around $40, lower for a second consecutive year and down further still from the June 2014 level of $100 per barrel.
Year-end commercial stocks are around 3 million barrels, providing inventories of around 300 million barrels higher than the past five-year average. In terms of days of forward cover, the Organisation for Economic Cooperation and Development (OECD) commercial stocks stood at around 63 days, approximately 45 days above the five-year average.
Global onshore storage capacity is almost full. Oil firms are stocking inventories in tankers. Market fundamentals are weak, with few prospects for improvement in the short term.
The oil industry is approaching 2016 with surplus supply, a weak demand growth of about 1.25 million barrels per day, raising world oil production in 2016 to 94.14 million barrels per day (bpd), compared to 92.66 million bpd in 2015.
Talks between the Organisation of the Petroleum Exporting Countries (OPEC) and the large non- OPEC producing countries, the United States and Russia, are deadlocked. OPEC members, particularly Saudi Arabia, along with the United Arab Emirates and Kuwait, refuse to cut production, asking that non-OPEC producers share the responsibility of stabilising markets by decreasing global oil supply. The gap remains wide, with no signs of a solution.
Gulf Cooperation Council (GCC) members, with a cost of production in the range of $10-$15 per barrel compared to an average cost of production of around $30 per barrel for countries with non-conventional oil (shale oil, tight oil, deep sea and ocean oil), argue that they are not ready to continue to forfeit additional market share with their low-cost oil. OPEC share of the market has decreased from two-thirds to one-third of the global supply.
OPEC is not a homogenous organisation. It embraces three groups with different interests. There are the countries with large oil reserves: Saudi Arabia, Iraq, the UAE, Kuwait, Venezuela and Iran. Their national interest, as holders of giant oil reserves, is to prolong the “oil era” as long as possible through a “reasonable” oil price that will sustain the dominance of oil in the global energy market. There are the low-reserve countries whose priority is high prices: Algeria, Libya, Nigeria, Indonesia and Ecuador. There are countries with large gas reserves: Iran, Qatar and Algeria.
Decision-making in the OPEC Council of Ministers is influenced by a number of interests, transcending those of a single group. Politics plays a large role in the decision-making process. For example, the large-reserve countries have often been at odds with each other. There is the Saudi-Iranian conflict. In 1990, Iraq occupied Kuwait, destroying some of its upstream facilities.
The prevalence of a low-price scenario affects both parts of the Arab region’s oil industry. According to the Arab Petroleum Investments Corporation (Apicorp): “Middle East crude will keep its Asian stronghold in the long term, GCC countries will look to expand on their existing downstream portfolio in Asia, while Iran, Iraq and the UAE rely on attractive upstream concessions involving Asian partners. But global competition remains stiff. Producers continue to channel their exports to the East, and the Middle East will need to adopt more creative strategies to secure its market share.”
Middle East oil firms are concluding multipurpose deals with Asian partners. Arab firms, in partnership with Asian oil companies, are investing billions of dollars in emerging Asian markets. Crude oil will be supplied to Asian refineries by the investing country, securing market share in the emerging markets. The Asian firms will have an opportunity to invest in the Arab upstream sector.
Kuwait, for example, will supply Vietnamese consumers in 2017 with petroleum products processed in the Nghi Son refinery and petrochemical complex that processes 200,000 bpd of Kuwaiti crude oil. The refinery is small by global standards but reflects a rising trend of GCC petroleum investments in Asian countries. The plant is a joint venture between Idemitsu Kosan, one of Japan’s largest independent refinery firms, and state-owned Kuwait Petroleum International. The refinery deal serves Vietnamese consumers. It will also open the opportunity for Asian oil companies to join Kuwait’s upstream sector.
The Middle East has been the major supplier of crude oil to the Asian market due to joint venture downstream projects between Asian and Arab countries. Middle East crude oil exports to Asia from 2010-14 grew from 13.2 million bpd to 13.9 million bpd.
Middle Eastern countries have practiced aggressive and attractive pricing schemes to defend their Asian market share. Cash-squeezed Indian refineries, for example, were given up to three months’ grace period, equivalent to $0.50- $0.75 discount per barrel, according to Apicorp.
Sales to Europe decreased from 2.4 million bpd to 2.1 million bpd during 2010-14, in the face of lower European demand growth and rising competition from Russia and West Africa. While the majority of Middle East crude oil is exported to Asia, there is more crude heading lately to European markets. Saudi Arabia sent its first cargoes to Poland recently, replacing Russian crude. More shipments are expected in the coming period, as competition over market share with Russia becomes more aggressive.
The oil scene in the United States has witnessed fundamental changes in recent years. US refineries still import heavy crude oil from Middle Eastern countries, mainly from Saudi Arabia. The imports have been volatile. Saudi crude oil exports to the United States declined to 1 million bpd in August 2015, compared to 1.6 million bpd in April 2014.
Canada is the largest oil exporter to the United States, reaching a record 3.4 million bpd in August 2015. Canadian exports include oil extracted from tar sand and conventional oil.
Overall, US oil imports have declined substantially, as shale oil production reached around 4.2 million bpd prior to the oil price crash in June 2014. Low prices have led to a decline of investment in shale oil, as well as a decline in production to around 3.5 million bpd.
The Paris climate agreement constitutes a long-term challenge to the Arab petroleum industry. The deal will attempt to reduce emissions to a level that will cap the global average temperature to a rise “well below” 2 degrees Celsius compared to pre-industrial levels.
Some of the language in the agreement is legally binding within the UN framework.
So, too, is the $100 billion fund from developed countries to assist emerging and developing countries decarbonise their energy basket, meaning, in effect, moving away from burning fossil fuels to clean energy sources, such as renewables and nuclear. The emission target is not legally binding and will be determined by the signatories themselves.
The effect on the Arab petroleum industry is clear. Use of fossil fuels, both oil and gas, will be minimised over the long term, if all nations implement the agreement.
Does the Paris agreement mean the end of the hydrocarbon industry? Not really. What it means, is that more investments will be made in renewable energy than what is already taking place, and less investment in the hydrocarbon industry. There will be a transitory energy period during the next few decades.