The bear necessities
Opec has tried to put a floor in the price. But further strength in 2017 will depend on the reaction of other suppliers and aversion of many risks
Opec has done its best. Now the ball's in the other court.
All being well-and that means no major geopolitical shock or collapse of a big producer country-oil prices should trade between $50 and $60 a barrel in 2017. Brief dips beneath that range are plausible and the occasional rally might lift the price into the low $60s. But Opec has now put a floor in place and others-not least tight oil producers-will install the ceiling. Feel confident with the price, but don't get carried away.
On the supply side, Opec's 30 November agreement will be the dominant bullish theme for 2017. The deal took some in the market by surprise and scepticism lingers. The doubters have a few sources. First, as even former Saudi oil minister Ali al-Naimi admitted after the deal, Opec's members have a history of cheating their quotas. In theory, economically straitened members like Venezuela might find it hard to resist pushing more supply as the price rises.
That's less likely this time around, at least in the short term. Talking of a unified purpose in Opec is always silly-the members have too many competing interests-but there is consensus about the need to lift the oil price and the need to restrict supply. For now, they're reading from the same communiqué.
Still, the observance of the cuts will be a major focus for market watchers, especially because Russia's pledge to cut 300,000 barrels a day of its own supply is, in Opec's view, a condition of the deal. Kazakhstan, Azerbaijan, Oman and even Mexico are expected to form the rest of the non-Opec group that will "cut" supply-in Mexico's case, this will mean decline that would have happened anyway.
Russia's commitment is where the biggest doubts arise. It has reneged on pledges to help Opec in the past. And even if production does retreat in the first half of 2017, as energy minister Alexander Novak says, exports of crude oil and products might not. If that is to be Russia's game, it will take some months for the market to figure it out-the country's exports aren't as easily tracked as Opec's mostly seaborne barrels are.
But don't get caught up with doubts about the Opec deal and its terms. The key take-away from the months of negotiations and squabbling that led to the end-November deal is that Saudi Arabia has abolished Naimi's non-intervention policy. It wants the oil price higher. If the latest Opec deal begins to fray, the group will try to patch it up. If stock draws aren't visible by June, Opec will extend its deal too. The group has reverted to old, tested behaviour. Market sentiment will adjust to reflect this. And, as Saudi Arabia and Kuwait bring the Neutral Zone back on stream, they'll have a ready weapon (0.55m b/d more spare capacity) with which to scare others.
Assuming the core Opec members stick to their plan, Libya and Nigeria will in 2017 be relentlessly under the market's microscope. Exempt from Opec's quota system, their success in restoring conflict-hit production will determine the effect of the group's cuts. Between them, another 0.6m-0.8m b/d of supply is plausible-and would make Opec's 1.2m b/d of cuts look rather puny. Yet Libya's political chaos is, if anything, deepening, and Nigeria's underlying Delta problems are not over. This leaves an uncomfortable level of price direction in the hands of young men with grievances and guns.
The other big source of price direction in 2017 emanates from across the Atlantic. At $55/b or so, no one will launch big expensive new oil sands or deep-water projects. (BP's decision to press ahead with Mad Dog 2 was exceptional, not the start of a trend.) But American tight oil producers will feel emboldened. The US rig count, already rising again as 2016 petered out, will be a constant headwind facing oil bulls.
Above all, new questions will be asked about the future of global trade in 2017. That the questions are asked at all should worry oil bulls
Crucially, the market will at last find out in 2017 just how reactive the Permian, Eagle Ford and Bakken are to a post-crash price rise. The analysis of that patch of the oil market and its ability to swing higher has been theoretical and speculative so far. Tight oil has never been through the recovery part of the oil-price cycle. If nothing else, lots of producers will spend the end of 2016 locking in hedges that will keep them afloat next year. Expect more American oil.
Rising rig numbers and a return to production growth in the US unconventional sector are reasons to think prices can only go so far in 2017-topping out at around $60/b. But the demand side of the market is just as significant. The 1.25m b/d of consumption growth expected from the International Energy Agency in 2017 isn't enough to set pulses racing. And several traps are lurking too.
The biggest risk comes in a tangle of Trumponomics, the US Federal Reserve, the dollar, emerging markets, and OECD lethargy. Above all, new questions will be asked about the future of global trade in 2017. That the questions are asked at all should worry oil bulls.
The bearish case runs in the following way. Donald Trump's plans for a vast infrastructure-building programme will breed inflation-or the spectre of inflation-in the world's biggest economy. The US Federal Reserve is already minded to raise interest rates (it may have done so in mid-December, by the time you read this). Bond markets have begun to price this in. The inevitable and continued strengthening of the dollar this year will worsen the plight of emerging markets that soaked up dollar-linked debt, causing capital out-flows and asset depreciation. These countries are responsible for the bulk of oil consumption growth and, as their economies falter, so will oil demand.
This was always a danger of the Fed unwinding its easy-money policy, Trump or not. But now it's imminent-so 2017 will see a lot of macroeconomic analysis about the end of loose monetary policy tested too. On top of the strong dollar problem are others: turmoil in the EU thanks to Brexit, the Italian No vote in December's referendum, persistent banking weakness, and the French general election; and the threat of trade wars or a deterioration of international relations.
The EU might survive 2017 intact. But, as it lurches between crises, the array of political threats will surely hinder its economy. Meanwhile, China's economic shift (and the possibility that rising oil prices will slow its imports to fill strategic oil stocks) was already an enigma for the global economy. Trump's early antagonistic position with Beijing seems likely to create even more uncertainty. Will he live up to his rhetoric, sparking a trade war and tariffs, or is he just getting carried away on Twitter? A lot in 2017, not just for the oil market, hinges on the answer to that.
Trump might also be bullish for oil-blowing away any predictions of a $60/b ceiling for prices. This scenario centres around Iran. A raft of new sanctions, cancellations of President Obama's executive orders, and a fundamental rolling back of the nuclear deal all look plausible in light of Trump's hawkish language and how he constructs his cabinet. How much goading does Iran take before it resumes its nuclear programme and the talk is, once again, of war and threats to the Strait of Hormuz?
If that all sounds fanciful, some other geopolitical problems are less so. The November Opec deal might have come too late to save Venezuela from collapse in 2017. Its debt burden grows more onerous by the day and default is drawing nearer. The IMF predicts inflation will hit more than 1,600% next year. It is running out of money to import staple goods. A $5/b rise in the oil price is worth almost $4bn a year more to PdV, the state company. But lenders will demand much more than that from both the sovereign and the firm next year. At best, oil output will keep falling-it has already dropped by about 0.6m b/d during 2016. At worst, it implodes along-side Venezuela's economy.
So competing forces will buoy oil prices in 2017, but also weigh on them. Looked at from a distance, none of the themes are new: potential both for supply growth and supply disruption, on one side, and geopolitics and macroeconomic risks, on the other. The middling scenario-in which Trump's tweets give way to more measured policy, globalisation and the EU muddle on, Opec lives up to its cuts, dollar strength perks up emerging-markets exports to the US, and lender generosity keeps Venezuela afloat-might prevail.
If so, 2016's shocks will give way to more predictability for the oil industry. That's why we expect a price band in 2017 of $50-60/b. That's a goldilocks outcome-neither too hot, nor too cold. It won't spark the drilling frenzy of 2011-13, but it will be a lot more comfortable than the dark years since then. In 2017, the oil industry might even start to feel like some stability is returning.