Short-term gain, longer-term pain for crude oil
Crude oil has settled into a relatively tight range above $80/barrel, with forecasts weighing short-term upside risks against the potential of slowing demand growth and rising non-Opec production.
Head of Commodity Strategy
Opec ministers have started to arrive in Vienna for their meeting on Friday, a gathering which is already being described as possibly the most difficult since 2011. Back then, of course, a group of countries including Venezuela and Iran blocked a Saudi Arabian attempt to raise the group's production in order to curb soaring oil prices. Ali al-Naimi, the Saudi oil minister at the time, had called for a collective increase of 1.5 million barrels/day in order curb skyrocketing prices.
After hitting a post-global financial crisis low at $40/barrel in 2009, the disruptions in North Africa and the Middle East caused by the Arab Spring saw Brent crude oil soar above $120/b by April 2011.
Saudi Arabia chose to ignore the refusal and during the first eight months of 2011 increased production by 1.6 million b/d. As a result, the price of oil stabilised and subsequently spent the following three years averaging $110/b before surging US shale oil production helped send it sharply lower during the second half of 2014.
Fast forward and we now find an oil price that has recovered from the 2016 low of $27/b to around $75/b. By successfully implementing and maintaining a production ceiling since January 2017, Opec together with a group of non-Opec producers led by Russia have managed to keep the price on an upward trajectory since last June. With the global overhang of supply gone and Brent crude challenging $80/b, Russia and Saudi Arabia surprised the market last month by starting to talk about raising production.
Faced with rising pressure from emerging market economies feeling the economic impact of rising fuel costs, a stronger dollar, and higher (dollar) funding costs, the Saudis felt the need to adjust production instead of risking slowing demand growth. Once again, however, the decision has become a political hot potato. Not least after President Trump singled out Opec as being the culprit behind surging oil prices in an April tweet.
Iran’s oil minister instead put the blame squarely on the US given the current sanctions on Venezuela, and soon Iran as well.
The main reason why a production rise is back on the agenda is Opec’s over delivery of production cuts. The economic collapse in Venezuela and problems in Angola have seen those countries' production levels fall below their target by more than 600,000 barrels/day. Raising production in order to return the collective compliance to 100% from its current +160% would not alter the agreement to keep production capped. The only question would be how to share the beans among those few producers, including Saudi Arabia and Russia, that are currently able to increase output.
On that basis,we expect Opec to agree to maintain the current ceiling while agreeing to increase production in order to return compliance towards 100%.
Iran and Venezuela may end up opposing the agreement, but as we saw in 201, this would not prevent other producers from going on their own.
The price impact should therefore be limited with no producer currently wanting to see their hard work unravel by raising production by more than the market can absorb. Brent crude is likely to remain within a $71 to $81/b range for the foreseeable future. In the short term, supply disruptions will continue to support the market while later on towards 2019 questions about demand growth strength may begin to attract negative price attention.
The risk of supply being disrupted has once again been highlighted by the collapse this week in exports from Libya. This after recent fighting led to the closure of the important Ras Lanuf oil port. The market reaction has been relatively subdued given the focus on Vienna but it highlights the continued short to medium term risk of higher prices. Something that helps justify Saudi’s attempt to keep prices capped by turning up the oil taps a couple of notches.
A looming trade war between the US and China together with the mentioned risk of an EM slowdown spreading to DM may both limit the upside to crude and therefore also the need for strong action from the oil ministers meeting in Vienna.
Twitter users can follow events as they unfold from dozens of the finest energy reporters in Vienna by using the hashtag #OOTT.
Later today at 14:30 GMT the US Energy Information Administration will publish its weekly update on US stocks of oil and fuels together with trade data and production estimates.
The results and charts will be tweeted to our hashtag #SaxoStrats.
Given the current focus on Vienna, the price impact should be relatively limited unless we see a major divergence from expectations.