By Irina Slav, a writer for the U.S.-based Divergente LLC consulting firm with over a decade of experience writing on the oil and gas industry. Originally published at OilPrice
It has become painfully obvious that the much-hyped OPEC agreement to reduce global oil production by close to 2 million bpd won’t have the effect that its initiators had hoped for. True, crude has jumped above US$50 but failed to pass the US$55 barrier and move closer to US$60, which would have solved a lot of problems for some of the world’s biggest producers.
This price increase, however, has spurred optimism among some producers and motivated them to plan output ramp-ups, which will in turn dampen the upward potential of crude more effectively than growing doubts about top producers’ willingness to stick to their commitments under the historical agreement.
Let’s look at shale boomers, for instance: according to Tom Kloza, the global chief of energy analysis at the Oil Price Information Service, shale producers can add as much as half a million bpd to their output this year. They don’t even have to want to add so much – they may well have to, prompted by their lenders.
Then there is that doubt that the parties to the production cut agreement will be tempted to cheat and won’t be able or willing to resist the temptation. The three most likely cheaters seem to be Iraq, Iran, and Saudi Arabia. Iraq, because it is still locked in its fight with the Islamic State and needs all the petrodollars it can get its hands on. Iran, because it is in a rush to revive its energy industry and has made it clear repeatedly it has no intention to dance to any tune that Saudi Arabia plays.
Then there is Saudi Arabia itself, which spearheaded the latest attempt by OPEC to give prices a big push upwards. Saudi Arabia and Iran are regional archrivals. Now, with most sanctions lifted, Iran is eager to re-enter global oil markets, targeting some of Saudi Arabia’s biggest clients, such as China and India. It’s hard to believe, as Osama Rizvi noted in an article for Oilprice, that Riyadh will sit idly by, watching Tehran take a bite out of its market share.
Of course, markets also have to contend with the two exempted OPEC members, which are both doing their best to increase their output. Libya says it’s close to reaching a milestone of 900,000 bpd, on track to restore its production to pre-war levels. By the end of 2017, Libya plans to pump 1.1 million bpd.
Nigeria is also slowly but surely raising production even though it is still fighting with militants in the Niger Delta and the Boko Haram terrorist group. The country, however, has managed to raise its output to 1.6 million bpd and, according to President Buhari, should further improve it to 2.2 million bpd.
To further complicate matters, there is the duration of the cut agreement. As Tom Kloza notes in an interview for CNBC, it might well be over in six months, which is the term that the parties agreed. If someone cheats and/or if prices fail to reach the levels that most participants in the agreement are happy with, chances are that the cut won’t be prolonged into the second half of the year.
All of this means that supply is going to exceed demand for yet another year–the fourth in a row, in fact, as 2013 was the last year when demand was higher than supply. And this does not bode well for price trends over the next 12 months.
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North Sea oil is a good example of what is in effect a “rent stabilized” market — being a very high cost producer, when the price of oil falls, production (over time, it is sticky) falls. But when prices rise, so — eventually — does output.
Hard to see how meaningful price increases can be fully sustained because, for once, the economic theory matches reality (the elasticity of supply and demand).
Thats true for some producers, and for all in the long term, but many oil fields require high up front capital investments, but have very low marginal costs per barrel after that. In those situations, the response to a drop in oil prices can be to actually to increase production in order to keep cash flow moving. This seems to have been the situation in US tight oil and with gas for the past 2-3 years – while they were losing money in over-all terms, the price was higher than the marginal cost of production, so they kept the pumps going full blast so they could meet their bills.
With North Sea oil, production kept relatively constant right through the low oil price days of the 1990′s, despite much lower revenues than they were anticipating. I suspect the operators staved off bankruptcy through slashing back on capital investment. But as you can see from the first graph on that link production didn’t necessarily drop to follow a big drop in revenues.
The power of the Saudi’s has long rested not on the overall quantity of oil they possess, but that their oil is very cheap to produce. This has allowed them to develop deliberate over capacity so they have a greater ability to turn the taps on and off according to their geopolitical needs.
It is in the long term interest of the United Sates to keep the price of oil low and the cost of oil products high. There have been large investments made in improving fuel efficiency for autos, trucks, and planes but if the price of fuel remains low then there is little incentive to purchase these products. One way of achieving this goal is to tax oil. By taxing oil instead of one of its products such as gasoline, all economic endeavors that use it will be impacted. But what to do with the tax? It should be distributed equally to all legal adult US residents. Then they can spend the money to adjust their oil use to the new reality.
One interesting idea would be to have a variable tax, such that each barrel of oil arriving (or produced) in the US has an excise tax equal to, say, $100/barrel minus the actual cost of that barrel. Thus, if the price of oil is $20/barrel, the tax is $80/barrel – but if the price rises to $70/barrel, the tax is only $30/barrel.
This would stabilize the price of gasoline for consumers, as market fluctuations would be damped out. By increasing the excise cap over time, one could discourage fossil fuel use. (Not that the current administration would ever consider discouraging people from burning oil.)
*sigh*
You’d think that after energy delivered the best performance of all S&P 500 sectors in 2016 — returning over 25 percent — the oil bears would retreat to their clarty dens to lick their wounds and hibernate through the winter.
But no. Having failed to foresee $50 a barrel oil, now they insinuate that it can’t hold.
One of my equity sector models is long XLE (Energy Sector SPDR), simply because energy currently exhibits better momentum than some other sectors. Sticking with winning sectors and avoiding the laggards can add two or three percentage points of return.
It’s defined as a “glut” by virtue of misunderstanding the ongoing destruction of demand. The price oil companies need to make a profit -which is acknowledged in this article- drives more and more consumers out of the market -an unpleasant fact not recognized in the article. The rumors of peak oil’s demise have been exaggerated.
not to disagree with any point she’s made, but i figured that IF OPEC and the NOPEC producers hold to their promised cuts, we’d see a 600,000 barrel per day shortfall in the first half of this year:
http://www.economicpopulist.org/content/oil-production-cuts-could-result-600000-barrel-day-global-deficit-first-half-2017-6045
The oil companies would do well to sell all the oil they can before it is made obsolescent by some new form of energy such as cold fusion or BesslerWheel style gravity mills.
I’m betting on antimatter regulated by dilithium crystals.
trouble is, both US and China’s car sales were at record levels in 2016, with China’s much higher…a lot of old equipment will still run on oil for years…
It appears China’s prosperity, partly powered by low cost oil, has run into a problem. When one can’t see the street markers at noon, due to hydrocarbon smog, setting new car sales record is a questionable economic strategy.
Good! I like low gas prices! Nor do I drive more when they are low (inelastic demand).
So rejoice for the poor at least?
Riyadh would LOVE to drastically cut back production to get the price back up.
The OPEC players ALL need $100 / bbl oil.
It’s their Social Rent that they have to pay.
This is largely driven by their exponentially increasing populations. ( Iran being an outlier in this instance. )
What we are all looking at is the end of days for the OPEC cartel.
For, with fracking, most of the world’s oil lies outside OPEC.
Russia can’t frack, though they’re trying. Russia does have a, theoretically, frackable oil zone that contains about 300 times as much oil as Saudi Arabia. It reaches from the Urals to the Baltic Sea to the Black Sea. It was discovered in 1953 — and kept a Soviet state secret.
Similar monster plays exist all over in both gas and oil.
The only nations to master fracking, America and Canada, show that all prior understandings about recoverable oil, globally, are miles off base.
Any huge price jump requires a hot war to crank it up.
Look what warfare did to Libyan production.