The OPEC Oil Market Gambit
The latest news in the declining oil price saga comes from Saudi Arabia. Last week softening prices of Brent crude oil, the global benchmark, appeared to be resulting from weaker growth prospects in Europe and Asia. This week, according to a Reuters exclusive, the Saudis suggested that market share is preferable to them over the higher prices that other OPEC members such as Venezuela prefer. However, senior Saudi officials would not comment on this market share agenda that was reported as a result of last weeks investor and analyst meetings in New York, where Reuters obtained their information. It is also hypothesized that the Saudi trial balloons could be a vehicle to help other OPEC members see the wisdom in all members sharing in production cuts to shore up prices, not just the Saudis, which is par for the course.
By the November 27th meeting, more clarity from OPEC is expected. Concerns about U.S. oil supply growth with the potential for glut have been on the radar of numerous analysts for over a year. The prices of Brent crude and West Texas Intermediate (WTI) have fallen in tandem in the last few months. WTI dropped to $85 Friday October 10; January WTI futures fell $5.03 since Sept. 30 to $84.73 a barrel today on the New York Mercantile Exchange. The Energy Information Administration (EIA) noted October 8:
The price of North Sea Brent crude oil,[the global benchmark], has fallen to around $91 per barrel, the lowest level in more than two years and about 21% lower than its year-to-date peak of $115 per barrel on June 19. Average monthly Brent spot prices had traded within a narrow $5 per barrel range, from $107 to $112 per barrel, for 13 consecutive months through July 2014.
Saudi Arabia, the OPEC producer with the most influence, has made adjustments to production and pricing. Saudi Arabia cut its crude production by about 400,000 barrels a day in August. This reduction was tied to lower exports to Asian markets. OPEC said it had reduced estimated demand for its crude by 200,000 barrels a day for 2015. The EIA curbed its forecasts for OPEC oil and other liquid fuels production to 35.51 million barrels a day in 2015, down 350,000 bpd from last month’s forecast. For crude oil output alone the EIA cut its forecast by 300,000 bpd to 29.24 million bpd. In September, OPEC pumped nearly 31 million bpd. The EIA projects that Brent crude oil prices will average $98 a barrel in the fourth-quarter of 2014. Brent traded around $88 as of early afternoon October 13th.
U.S. crude oil production was little changed by in EIA’s brief of October 7th. U.S. 2015 oil production of 9.50 million bpd is projected compared with 9.53 million bpd a month earlier. Price expectations for Brent were lowered to $101.67 a barrel in 2015, compared with $103 a barrel. Brent crude oil prices will average $98 a barrel in the fourth-quarter of 2014, projects the EIA. Given the most recent additional declines of WTI and Brent prices, there could be new adjustments to prices and production expectations forthcoming. Below are the shale oil basins responsible for the U.S.’s additional oil production that reduces oil imports.
Supply disruptions are still continuing in the upper ranges of the last two years. But overall, the market is well supplied. According to a Business Day article: ”The kingdom would need to reduce output about 500,000 bopd to eliminate the supply glut now stemming from the highest U.S. output in three decades. U.S. shale oil output and the return of production in Libya has contributed to a glut of crude in the market.”
Oil Market Reversals
By the fall of 2013, U.S. oil production was recognized as a moderator of global oil prices, insulating the U.S. and other countries from the volatility of OPEC and non-OPEC production outages. The U.S. was no longer just a price-taker, as set by OPEC. One year later, the Saudis are cutting prices to their Asian customers and resetting the balance of OPEC power. It really is not in the best interest of the Saudis to pressure U.S. producers into reversing their production to the point of ruin, although some moderation may be desirable to OPEC in the medium term.
The U.S. economy has been the one bright spot of global growth, and the U.S. economy has been pulled out of recession partly by the economic activities and investment surrounding the U.S. oil and gas resurgence. The Saudis, and the rest of OPEC, have reasons to keep prices nearer to $100 to aid their economies and fill budget coffers. U.S. producers may slow production down given the price signals, but they will wait for another day to drill, sometime into the near future. This will be more like a dance as this chart illustrates.
This chart below is the longer term view that markets and investors should understand, rather than just short-term factors and headlines.
World GDP is expected to be steady. World liquids production capacity is not profligate. The IMF recently forecast global growth of 3.3% for 2014 and 3.5% for 2015. The Euro zone is slated for gradual recovery. China’s growth declines slightly in 2015, but still above the 7% growth rate level; India picks up some slack in Asia. In the Middle East/North Africa (MENA) growth increases, including Afghanistan and Pakistan.
The IMF also cites geopolitical risks having the potential to raise fuel costs. Markets have shrugged off geopolitical tensions once again, even while in the midst of utter chaos in Syria, conflicts in Iraq, not to mention Russia’s impact on the Ukraine and Europe at-large.
In conclusion, while markets have punished energy stocks, the bruising has seemed ahead of fundamentals. Obviously, if economic growth reverses, then a different reaction is warranted. Oil price realizations are a great moderator, and U.S. producers will adjust. For now, the immediate new normal may be $90 Brent and a lower WTI, accordingly, until some new information or policy adjustments come to light. In light of the Saudi-OPEC gambit with oil prices, be careful what you wish for: market share that disrupts the main growth engine of the global economy may not have the desirable outcome.