Opec to extend, tight oil to grow
The group is expected to extend its cuts deal. But global supply could still surge
Opec is almost certain to extend its cuts for the second half of 2017 when it meets on 25 May in Vienna. The group's most powerful member, Saudi Arabia, has signalled to the market to expect a rollover. Its neighbours in the Gulf, including Iraq, say they are on board. Venezuela is desperate for higher prices.
"The deal is 99% done," one insider told Petroleum Economist recently. Oil prices haven't risen as high as most members would like, but they're well above the level they would have reached without a deal, and all members fear a sell-off if an extension isn't agreed later this month.
Opec thinks one more heave will be enough to help the market turn a corner in the second half of the year. Most analysts agree. The International Energy Agency thinks the supply-demand balance will tighten significantly in the third and fourth quarters. Although OECD stocks rose earlier this year, they should start drawing down as refineries come out of maintenance and the US driving season kicks off. Bernstein, a research firm, reckons stocks will drop by 30m barrels per month throughout the second quarter.
These numbers matter because stocks remain unusually high, despite the fall in supply from non-Opec countries last year and Opec's decision to cut production by 1.2m barrels a day. Khalid al-Falih, Saudi Arabia's oil minister, suggested in March that Opec should keep cutting until the OECD inventory was back down to its five-year average. Opec's most recent data, in April, showed the excess to be 275m barrels. The comparable figure for last year was 356m—progress, but a way to go yet.
The overhang remains so big for two reasons: a surge in supply in the second half of 2016 and a weakening of demand growth. Opec secretary-general Mohammad Barkindo noted recently that between September and December 2016, in the run-up to the start of the cuts, global production rose by 2.3m b/d.
Demand hasn't mopped up the excess, though in judging how strong it will be this year the jury is out. The IEA expects an increase of 1.3m b/d for 2017, 300,000 b/d less than last year. The effect of cheaper oil on consumer thirst for it has worn off, say many analysts. Others are more bullish. Patrick Pouyanné, chief executive of France's Total, reckons the world will burn 1.5m b/d more oil this year than last. The working assumption in Saudi Arabia's oil ministry is said to be 1.6m b/d.
The response of oil consumers in the second half of the year will be important to the success of Opec's plan to bring balance back to supply and demand—but not as significant as the performance of producers who might not, or definitely won't, be part of the deal. They have the potential to wreck Opec's plans and postpone the key rebalancing of stocks.
Although Russia joined in the cuts for the first half of 2017, it isn't yet clear it will agree for the second half. Almost all the country's big producers have told their shareholders to expect year-on-year output growth, and its output always picks up once winter ends. While other non-Opec countries like Mexico, where production is falling organically anyway, might stay with the plan, others will find an extension harder to accept. Kazakhstan, for example, is eager to ramp up output from its much-delayed Kashagan field. It could add 200,000 b/d to supply.
Libya and Nigeria are the other problems facing Opec. Both are members of the group, but exempt from the cuts because conflict has shut in so much of their output capacity. Yet Libya's oil chief, Mustafa Sanallah, told Petroleum Economist in late April that output would rise by around 0.5m b/d to 1m b/d by August. If Nigeria can sustain the calm in its oil-rich Delta region, where saboteurs struck facilities repeatedly last year, it could add a similar volume.
Brazil, Canada, Norway, and Ghana—non-participants to last year's deal with Opec—should also chip in with more oil this year. Many of their projects were sanctioned when oil prices were higher and are only now reaching the market.
Tight oil resurgence
But the US is the biggest problem for Opec. The number of rigs drilling for oil there has risen by more than 60% since last September. Moreover, notes Total's Pouyanné, well productivity has almost doubled in the downturn. Total US liquids supply is expected to grow by more than 1m b/d this year, says the country's Energy Information Administration. During 2016, it fell by almost 300,000 b/d.
The US resurgence is a direct response to Opec's efforts to raise prices. The elasticity of American supply—helped by Wall Street's willingness to fund growth and producers' alacrity in hedging when oil prices bounce higher—has surprised Opec. And if the trend continues, it may force the group to rethink its strategy.
As much as Saudi Arabia wants a higher oil price, it does not want to repeat the 1980s experience of repeatedly cutting supply to prop up the market—only to subsidise the growth of other producers. So while this month's Opec meeting seems certain to bring an extension, enthusiasm for the strategy will eventually wane if further cuts only serve to buoy rivals.
This article appeared in the AOGC daily newsletter, produced by Petroleum Economist for attendees of the 19th Asia Oil and Gas Conference held in Kuala Lumpar.