Opec's efforts to cut supply will be the main theme of 2017 and prices will rise. But the outlook is still fraught with risk and uncertainty
Oil prices will rise in 2017. But, failing a supply-side shock or deeper-than-expected cuts from Opec, $60 a barrel will be the upper limit. Before that level is reached, bears still pose a threat too. And that price will be the rough ceiling, not a basecamp for bigger climbs.
The tone for the year will be set before it begins - on 30 November, when Opec's ministers gather around the horseshoe table at the group's headquarters on Vienna's Helferstorferstrasse. Any cuts they agree will only be felt in physical markets from January.
The end-November meeting is probably too soon for Opec to thrash out a meaningful deal. The one on the table, established in Algiers at the end of September, would take between 0.83m barrels a day and 1.23m b/d out of global supply (compared with the group's October output). That's significant - the upper limit would be enough to align the group's output with the demand for its crude in the first half of 2017; and put it in deficit in the second half.
More than that, the Algiers deal, even if it can't be fully enacted in November, means that Saudi Arabia's experiment with laissez-faire economics is over, for now. The kingdom is tired of $45/b oil. It hurts its economy and undermines other plans, like the Aramco IPO. So Riyadh wants the price higher. The market will get used to that fact in 2017, because Opec supply-side management will be a central theme next year.
But four caveats are attached, and in combination they make Opec's job difficult. First, whatever was said in Algiers, agreement is by no means guaranteed. Iraq, Iran and others still don't even accept the secondary-source numbers Opec's secretariat must use to establish baselines. Iraq still insists that it ought to be exempt from any quotas because its current production is lower than it would have been if not for decades of war and sanctions.
Second, Iran still wants to increase output by another 200,000 b/d, if not more. Its production target of 4m b/d is political - and, despite the rapid rise since January, will probably not be reached in the first half of 2017. Still, its stance is what matters. Saudi Arabia will, as ever, need to make the bulk of production cuts in any deal - but if it can't swallow an exemption for Iran, the cuts won't happen.
Third, output growth from Nigeria and Libya in 2017 may neutralise cuts made by other members. Libya had already increased output by about 400,000 b/d between August and November, to 0.66m b/d. Further sharp rises will be more difficult - too much infrastructure has been damaged in the past two years. But the market discounted the ingenuity of Libyan engineers to patch things up after the civil war in 2011. So it's risky to bet against National Oil Company hitting its target of 0.9m b/d in early 2017 and reaching technical capacity of 1.2m b/d later in the year.
A sustained recovery in Nigerian output, which averaged 1.57m b/d in October, is more doubtful. It depends on the government's ability to settle the Niger Delta. But the approach of President Muhammadu Buhari's government to the saboteurs has oscillated between negotiations and threats of destruction. A long-term answer to ecological and economic devastation in the Delta isn't going to arrive in 2017. So the risk of more unrest will remain. Still, Nigeria can plausibly add 300,000 b/d to supply.
The fourth problem is outside Opec. Russian supply, with or without a pledge to support any Opec cuts, will keep rising in 2017. Too much momentum has been built into recovery efficiency in Western Siberia for it to stop in the coming months. Even if the Kremlin could, against expectations, lean on producers to slow their projects, weakness in Russia's domestic demand will still free up extra barrels for export. Russia has never cooperated with Opec, even when it said it would. It remains an implacable geopolitical opponent of Saudi Arabia in the Middle East. Notions that it will do Riyadh a favour are fanciful.
Throw in rising supply from others too. In Kazakhstan, output from the restarted Kashagan field should add at least 200,000 b/d by mid-2017. Projects launched when prices were higher in the Gulf of Mexico will lift its output by almost 15%, to 1.9m b/d in 2017. The UK's North Sea, Ghana, Canada (after a fire-hit 2016) will also chip in with more barrels next year.
That's why so much depends on Opec. The International Energy Agency (IEA) reckons on a 0.5m-b/d rise in non-Opec supply next year. So assuming the agency's forecast for global demand growth in 2017 - 1.2m b/d - is correct, cuts by Opec in line with its tighter target (1.23m b/d), less the additions from non-Opec, would reduce total global supply by about 0.7m b/d. The overhang in the second and third quarters of 2016 narrowed to around 250,000 b/d. So the Opec cuts would bring a deficit, quicker than many people think.
The problem is that the price rise implied by a tighter oil market in 2017 would staunch non-Opec supply losses - trigging more drilling in the Permian, for example - and, as ever, threaten Opec's discipline. Getting an agreement to cut at $45/b has been difficult enough. If Brent honed in on$60/b - Saudi Arabia's not-so-private target - Opec's producers would be sorely tempted to lift volumes, especially if American rivals were already beavering away to do the same.
Demand in 2017 should also worry the market. China's economic transition is sinking in. It can no longer be relied on as it was, and although India's economy is growing fast, in volume terms it isn't yet a match. Compared with 2015's global demand surge of 1.8m b/d, the 1.2m b/d expected by the IEA in 2016 and 2017 says weaker oil prices aren't spurring consumers as they once did.
And Q4 2016's data could yet point to an even weaker outlook. When demand soared in 2015, its final quarter actually saw a seasonal drop of 400,000 b/d. Yet the IEA thinks the final quarter of 2016 - a year when it expects much weaker consumption growth - will add 170,000 b/d. If Q4 2016 behaves as Q4 2015 did, 2016's total demand growth will come in at just 1.14m b/d, or 200,000 b/d less than expected.
The uncertainties don't end there. Donald Trump's election in the US clouds the macroeconomic picture and adds some wrinkles to American supply projections. It probably lessens the chance of a Fed rate rise in December. If his initial policy efforts match his campaign rhetoric, he will swiftly lift taxes and regulations on producers, free up more land for drilling, and axe a bunch of pesky pollution rules. He'll try to kill off the Paris Agreement. He might revive TransCanada's Keystone XL pipeline, cheering Canada's oil sands producers. With control of Congress, the Environmental Protection Agency will be Trump's main adversary. But if he's successful, tight oil might get even cheaper and more oil will flow in North America.
He could also help out domestic American producers by wrecking the Iran deal, which might hurt its output plans. On the other hand, if he starts slapping tariffs on Chinese goods or tearing up international trade agreements - indeed, if Trump and Brexit really signify a big retreat in globalisation and the rise of mercantilism and nativism, to be confirmed with Marine Le Pen's victory in France in May - 2017 might bring a nasty shock for emerging economies, global economic growth and therefore demand for oil. Producers in that case might end 2017 wishing for the halcyon days of $45/b oil.
The other demand-side threat comes from electric vehicles (EVs) and a secular shift away from the internal-combustion engine. Too many oil execs still laugh off the potential of EVs, better batteries or even the use of more gas in transport. And if Trump succeeds in ruining the Paris Agreement it will certainly take some puff out of these alternatives. Yet the transition was getting underway before that climate deal - and despite the oil-price slump. A rising oil price in 2017 would only give more momentum to these changes.
In essence, Opec can prop up the market in 2017, even if it needs the months after November's meeting to settle the terms of its cuts. If it succeeds, prices will rise. Crude oil stocks will drain and start to look normal again by the fourth quarter. But supply and consumers will also respond. The safer bet is to assume Opec can put a floor in the market at $45/b, and everyone else can build the new ceiling, at $60.
This article is part of Outlook 2017, our annual book looking at energy market trends for the year ahead. To purchase a copy, click here