Views On Oil This Week

Vandana Hari, Analyst, Vanda Insights | Mumbai | September 23, 201617:39 IST

Benchmark NYMEX and Brent crude futures, currently locked in the $40s per barrel band, are vulnerable to downward pressure in the short term from factors such as an inconclusive producers’ meeting next week in Algiers to discuss production curbs, and rising supply from Russia and OPEC. Add to that, the threat of a body-blow to global oil demand in the longer term posed by the probability of a recession.

From the frying pan into the fire?

Two major closely-watched central bank meetings headlined the global financial markets this week, but did not have any discernible impact on the oil complex.

A meeting of the US Federal Open Market Committee on Sep 20-21 left interest rates unchanged, while signaling a hike in December, an outcome that was widely expected and factored into the markets.

On the other side of the world, the Bank of Japan on Sep 21 announced a radical shift in policy, setting a target of managing the interest rates on government bonds and letting that dictate its pace of bond-buying, in a fresh attempt to stimulate economic growth and push inflation to 2%.

The move surprised many and left some skeptical, but is likely to be closely watched by other central banks that are out of options, in case it turns out to be worth emulating. Nonetheless, the sentiment that central banks have run out of ammo to fuel recovery has taken hold, some analysts are flagging a sharp stock markets correction, and the “R” word has started cropping up more often in conversations and commentaries.

That hangs a big cloud of uncertainty over the oil markets.

Benchmark NYMEX and Brent crude futures, currently locked in the $40s per barrel band, are vulnerable to downward pressure in the short term from factors such as an inconclusive producers’ meeting next week in Algiers to discuss production curbs, and rising supply from Russia and OPEC. Add to that, the threat of a body-blow to global oil demand in the longer term posed by the probability of a recession.

Ropey “ROPEC” plans: The signal-to-noise ratio seemed to get worse as the much-hyped Russia-OPEC (let’s call it ROPEC) meeting scheduled Sep 28 on the sidelines of the World Energy Forum in the Algerian capital of Algiers drew closer.OPEC secretary-general Mohammed Barkindo last weekend stressed it was an informal meeting that would not take a decision, but if there was a consensus on action, an emergency meeting could be called to make a decision. Venezuelan President Nicolas Maduro, who has been lobbying fellow OPEC members relentlessly to act together to shore up prices, on Sep 19 declared that an oil production freeze deal was “close”, following a summit with the leaders of Iran and Ecuador.

Venezuela, battling one of its worst economic crises in decades, has been understandably over-optimistic about OPEC’s willingness and ability to help rebalance the markets, though its message is regularly overshadowed by signals from the Russia-Saudi Arabia-Iran triumvirate and the geopolitical tensions between Riyadh and Tehran.

Oversupply at 9 mil b/d? There were some raised eyebrows when Venezuelan Oil Minister, Eulogio Del Pino pegged global oil oversupply at a whopping 9 mil b/d in an interview with state oil company PDVSA at the start of the week, saying that was the volume that needed to be removed from global production of 94 mil b/d to be level with consumption. Oversupply in the current market downturn, which began in mid-2014, was estimated at 2.5 mil b/d at its worst, around the second quarter of 2015, by the International Energy Agency. We proffered three possible reasons for Del Pino’s bloated figure:

1)He actually meant to say 900,000 b/d, which comes closer to the average oversupply this year

2)9 mil b/d is the number Del Pino reckons needs to be withdrawn from the market for crude to climb to $70/barrel, Venezuela’s oft-repeated “ideal” crude price.

3) The minister simply wanted to rise above the market din and grab attention (which he did).

Looks like everyone is supportive but no one wants to do it: Next week’s meeting should give us a good idea of whether the top two oil producers Russia and Saudi Arabia are willing to go past banal and repetitive statements on the need to “cooperate to stabilize” oil markets. Iran’s expected participation in the Algiers meeting after it snubbed the April “freeze” talks in Doha have prompted a cynical market to take notice, though we recommend holding on to the cynicism a bit longer.

Iran, though unlikely to agree to freeze its production until it reaches its pre-sanctions production levels of 4.1-4.2 million b/d, is not the only stumbling block in an orderly consensus on what, if anything, OPEC and Russia should do about the persistent glut in the oil markets. Output in OPEC members, Libya and Nigeria, plagued by civil war and militancy in the producing Niger Delta respectively, is also languishing below full potential, making them likely unamenable to capping production at current levels.

Libya this month ramped up output by nearly 70% from August to around 450,000 b/d, resuming exports from its Ras Lanuf terminal for the first time since 2014. The recently reunified National Oil Corporation wants to boost production to 950,000 b/d by year-end.

The country would still be well below its pre-crisis level of 1.6 mil b/d. Nigeria, whose output was nearly halved in May by resurgent militant activity in the Niger Delta, and continues to suffer attacks on its infrastructure, wants to get back up to 1.8 mil b/d by October and 2 mil b/d by December, Minister of State for Petroleum Emmanuel Ibe Kachikwu said Sep 19. The West African country’s 2016 budget is benchmarked against a production capacity of 2.2 mil b/d. To try and reach that average for the whole year, Nigeria will want to pump all it can in the coming months.

Russia has advocated giving Iran leeway to reach its pre-sanctions output before adopting a ceiling. If OPEC is to be even-handed, the argument would hold for Libya and Nigeria too. The only major OPEC producer with untapped potential but resigned to stalled output is Iraq, which achieved a remarkable 40% rise in production over the past two years to around 4.4 mil b/d. But low oil prices and the Islamic State incursion have combined to crimp investment in the country’s oil industry and left the government struggling to pay the foreign oil companies, which operate the oil fields as contractors, for a fee. “If [Islamic State militants] leave, we could produce 5 mil b/d next year,” State Oil Marketing Organization’s Director General Falah J Alamri told an industry conference in Singapore earlier this month. But, “we do not want to flood the market,” he hastened to add.

What if freeze thaws to voluntary ceilings: It is worth noting, recent reports suggest that the original “freeze” proposal – basically producers agreeing to hold output steady at an agreed baseline of recent production – may have morphed into “voluntary output ceilings”, which implies some of the producers could cap at a later date, once they have brought shut-in output back on stream. That route certainly looks more plausible for producing some kind of an agreement, but let’s take a close look at what it means:

Agreeing to cap output at current levels (under a freeze proposal) would have meant holding collective supply steady at around 33.24 mil b/d for OPEC’s 14 members (based on the August total as reported by the organization in its September monthly report, citing “secondary sources”) and at 10.7 mil b/d for Russia, based on independent surveys. OPEC’s 33.24 mil b/d August output overshoots its own projection of 31.7 mil b/d average demand for its oil in 2016. The current output by its 14 members is nearly 2.23 mil b/d higher than the average for 2014, when prices began sliding amid a global supply overhang, and 1.14 mil b/d higher than in 2015. The biggest contributors of the rise over the two years have been Iraq (+1.1 mil b/d), Saudi Arabia (+0.92 mil b/d) and Iran (+0.88 mil b/d). In comparison, Russian crude and condensate output in August was up just 130,000 b/d compared with its 2014 average and a bit below the 2015 average.

If Iran, Libya and Nigeria are to be allowed to reach their potential before capping production, that would in theory add another 2.5 mil b/d to current OPEC supply before the voluntary collective limit would kick in.

A voluntary ceiling inherently suggests less rigidity and lower discipline than the production limits adopted by OPEC in the past, the last one being a 4.2 mil b/d cut agreed effective January 2009, and would be open to myriad interpretations, sabotaging the effort from the start.

We outline below the possible outcomes of the Algiers meeting next week that are worth contemplating, along with their probabilities, and implications:

1) OPEC producers and Russia are unanimous that the current low prices are hurting everyone and something needs to be done, but fail to forge a consensus on the details of a production curb. No emergency meeting is scheduled, and the topic continues to simmer on the back burner until the next OPEC meeting 30 Nov.

Probability: Very high

Implication: Demand-supply rebalancing is left to market forces

2) The producers are unanimous that the current low prices are hurting everyone and something needs to be done but decide to leave the nitty-gritty of the action plan for an emergency meeting in the coming weeks.

Probability: Medium-Low

Implication: Market is kept on its toes a few more weeks. A concrete agreement may or may not happen down the road but even if it does, patchy compliance and resurgent US production as prices rise means demand-supply rebalancing is eventually left to market forces.

3) The producers agree that the current low oil prices are hurting everyone, they make all the right noises about “cooperating to stabilize the market”, but stop short of proposing anything concrete. The freeze/output curbs initiative is left to die a slow, natural death.

Probability: Low

Implication: Demand-supply rebalancing is left to market forces

4) The producers agree that the current low oil prices are hurting everyone, and agree a voluntary output curbs proposal, giving Iran and possibly some other members room to reach higher levels before capping their output, along with a time-plan for implementation.

Probability: Zero
 

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