How that oil prices are recovering from the depths of the crisis that began in 2014, when a softening global economy combined with OPEC’s aggression against US shale oil production sent fossil fuel prices crashing, the organisation’s members have agreed to extend a deal that has stabilised oil prices by curbing oversupply.
The bi-annual meeting of oil producing states, held on November 30 in Vienna, saw OPEC leaders extend production cuts for another nine months, and agree to review the deal when they meet again in June 2018. Analysts say the agreement is likely to be extended until the end of next year. But uncertainty looms over how to maintain stability once the deal is finally unwound.
This is a big issue for Gulf states trying to budget for vital economic diversification plans. So can OPEC deliver the numbers they need to make it work?
Why prices are rising
As this magazine went to print, oil prices stood at more than double their lowest point in the last two years, with the OPEC daily basket price at $60.87 a barrel.
Prices fell below $26 a barrel in January 2016, its lowest since 2003, as a result of oversupply both by OPEC producers and the impact of US shale, explains Sorana Parvulescu, a partner at global strategic consultants Control Risks. “Only after that point did Saudi Arabia and OPEC start implementing cuts to revive the price. In time, these cuts started to reduce the oversupply and push up the price to bring it to where it is now,” she says.
OPEC’s average crude oil production reached 32.59 million barrels per day (bpd) in October
Analysts attribute the current uptick in oil prices to heightened global demand from an improving world economy, along with successful efforts to curb production. “I think overall it’s a good story,” says Parvulescu. “From the perspective of oil producers, prices have gone up, and they are almost double what they were at their lowest point, so in some respects I think the worst is behind them,” she says.
Robin Mills, CEO of UAE-based energy consultancy Qamar Energy, also credits the steady growth to stronger global energy demand from China, the US, Europe and India, continuing OPEC cuts, and geopolitical concerns over unrest in Kurdistan weighing in to a lesser degree. “The market is finally going their way, even if it’s been a long and gradual road. The inventories have been coming down, which is what they’ve been trying to achieve,” says Mills.
Mills expects global oil prices to fall back in the first half of 2018, then rise in the second half to about $60-65 a barrel. But it’s in June 2018, when OPEC’s next moves will be deliberated in earnest.
“We forecast continued builds in global oil inventories through the first half of 2018 which will prevent OPEC from achieving the stated goal of lowering global inventories back to the five-year average. Therefore our expectation is for the production restraint to continue through 2018,” says Ann-Louise Hittle, Head of Macro Oils at Wood Mackenzie Energy Research Consultancy.
Oil versus reform
Of keen concern to OPEC’s Gulf constituency, in their efforts to keep prices steady, are the vast economic reform programmes they are collectively pursuing to diversify non-oil sectors and produce steady incomes.
“For their fiscal position and their currencies, especially with the ambitious reform programme that Saudi Arabia has planned, a lower oil price would immediately mean a deteriorating fiscal position and therefore less room for manoeuvre, in terms of going through with these reforms,” says Parvulescu.
At the same time they don’t want a significantly higher price either, partly because the low oil price environment has helped garner public and political commitment in GCC countries to economic reforms, she says. “If the higher oil prices returned too soon they [the public and political forces] would not allow them [the government] to make those critical changes that will set up the economy for different growth paths.”
As GCC nations work to gear their economies away from relying on oil revenues, and broaden into other sources of growth, with measures such as the introduction of VAT in 2018, stable oil prices will continue to be helpful in ensuring steady economic growth in these countries, Hittle says.
Sorana Parvulescu, partner at global strategic consultants Control Risk
Striking a balance is going to be vital in other ways. Oil prices will need to be high enough to support a reasonable fiscal deficit and still allow governments to pass reforms, while also being low enough to make sure shale production in the US doesn’t dislodge their market share, keeping momentum for diversification efforts and reforms domestically, she says.
After the cuts: the shale effect
At the press conference after November’s meeting, the key question was how to keep the oil price stable when production cuts are eventually wound down.
“Saudi Arabia’s oil minister was clear that the organisation has not yet worked out how it will unwind the deal. He said they are collecting data currently and studying closely what approach to use for ending the production restraint when the time is right,” says Hittle at Wood Mackenzie.
“But oil minister Khalid Al Falih was also clear that OPEC did not intend to boost production sharply the day the agreement ends and that it will end in a managed manner to avoid swamping the market with oversupply.”
The big threat to OPEC’s efforts remain US and North American production, Parvulescu says. The downside risk of unwinding OPEC cuts have been the likelihood of the US and Canada producing more oil, which will push crude prices down again.
That reality is a future OPEC might not be able to avoid, at least beyond the mid-term, it has recently conceded. Curbing supply has raised oil prices but will also help North American shale production surge to 7.5 million barrels in 2021, according to the organisation’s most recent World Outlook report.
However, 2025 is when OPEC estimates shale production will peak – shale fields can only produce large quantities of oil at first before shrinking rapidly – putting it in prime position to grow the market with its own large stock of untapped reserves. With nearly two thirds of global crude production and 81.5 percent of proven reserves – 65.5 percent of which are in the Middle East – OPEC can afford to play the long game.
Robin Mills, CEO of UAE-based energy consultancy Qamar Energy
Force majeure
In the near-term, in the absence of a major geopolitical shock, oil prices are expected to stabilise in 2018, analysts say.
“Assuming no major geopolitical shock or nothing significant happens between now and at least 2018, we expect oil prices to fare at about the same rate they are now or maybe slightly higher,” says Parvulescu.
Natural disasters such as hurricane Harvey denting US production, a conflict with North Korea disrupting the Asian supply chain, or renewed sanctions on Iran, are all factors which could cause enough pressure on the market to push prices up in the Middle East, or trigger a reduction in production in one of the major oil-producing countries, pushing the price up, according to Parvulescu.
But prices “will stabilise in 2018,” she says. “Everyone is working to prevent a long-term oil supply shortage, and while downward pressure will bring prices into the lower half of the $50 to $60 range, supply and demand will tighten in the second half of 2018, and prices will recover again.”
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