Oil producers must take tough decisions to restore equilibrium
Several Opec and major non-Opec members have signed up for confabulations over a “production freeze” proposal scheduled for April 17 in Doha, suggesting a fresh groundswell of support for an interventionist approach to stem the growing tide of oil in an oversupplied market.
Holding output steady at January 2016 levels – if such an agreement is indeed forged and complied with – may rein in the handful of producing countries actually able and wanting to raise output, but by definition won’t reduce the 1.5-2 million b/d current oversupply or propel the market towards supply-demand equilibrium. Only a production cut could do that.
Iran, poised to displace the US as the largest contributor to global crude supply growth this year, is expected to stay out of any freeze agreement, though there are signs of an emerging consensus to proceed without Iran. War-torn Libya, whose production has been languishing around 300,000 b/d against a potential of 1.6 million b/d, has also declined to participate.
A sanctions-free Iran has been aggressively courting customers and resumed term and spot crude sales to buyers in Europe after a nearly four-year hiatus, but it still cannot be paid in US dollars and its shipments are not getting full protection and indemnity (P&I) cover. The country managed to raise production by a modest 210,000 b/d in February, the first full month after the lifting of sanctions, reinforcing the view that its return to full potential will be a slow and gradual one.
As the drumbeat over the freeze plan grew through March, Brent as well as Nymex light sweet crude futures clambered to year-to-date highs above US$41/barrel, 50-56 per cent above their respective January nadirs, in another reminder of sentiment and snap judgment prevailing over logic and cool reasoning in the oil markets.
As March wound down, the futility of a freeze started sinking in, and crude futures let out some of the steam. Brent slid below the US$40 psychological mark, defying the upward pressure from a weaker US dollar and diverging from an uptick in equities spurred by dovish comments from Federal Reserve Chair Janet Yellen March 29, which pushed expectations of the next rate hike farther down the road.
A landmark agreement between Kuwait and Saudi Arabia March 29 to restart production from their jointly operated 300,000 b/d Khafji oilfield in the offshore Partitioned Neutral Zone, which was unilaterally shut by Saudi Arabia in October 2014 following a dispute, added a further bearish tone to the markets.
Interestingly, lurking in the shadow of the freeze proposal have been statements from Russia – world’s largest oil producer and one of the architects of the tentative precursor agreement forged with Saudi Arabia, Qatar and Venezuela in Doha on February 16 – about the possibility of Opec and non-Opec producers agreeing to a 5 per cent output cut.
Opec secretary-general Abdallah el-Badri, saying the producers could consider “other steps” after the Doha meeting, suggests consensus over a freeze could pave the way for a cut, though there’s a wide philosophical chasm between the two. Ecuador President Rafael Correa said producers must be willing to “control output and even reduce it if necessary” to bring prices into equilibrium. His oil minister, Carlos Pareja, hopes to bring non-Opec producers Colombia and Mexico to the Doha table to represent a joint Latin American position.
Add to that growing concern among Saudi Arabia’s regional allies over the Kingdom green-lighting major investments in its oil sector despite reducing spending elsewhere to boost oil and gas production capacity. Saudi Arabia, with a total production capacity of 12.5 million b/d including fields in the Partitioned Neutral Zone, and an output of 10.2 million b/d, is the only Opec member with significant spare capacity.
So could Doha turn into a coalition of the willing and a Waterloo for the controversial market-share strategy pushed by Saudi Arabia at Opec’s November 2014 meeting? Only time will tell. Using January production levels as a base for apportioning any cuts gets over the hurdle of Opec having effectively abandoned individual member country quotas since 2012. However, compliance with output reduction deals both within and outside the organisation has been poor historically.
Opec lowered the estimated 2016 average demand for its crude to 31.52 million b/d in its March monthly report, which is about 820,000 b/d below what its members collectively pumped in February, according to Platts data.
The consumption side of the equation also remains uncertain, though the International Energy Agency maintained its 1.2 million b/d global oil demand growth forecast for 2016 in its March report. US gasoline demand on a four-week moving average basis was up by a smart 5 per cent or 447,000 b/d on year at the end of March, but countered by weakening distillates use.
Chinese implied oil demand ticked up a paltry 0.9 per cent on year over January-February, according to Platts data. And fresh economic challenges in Europe raise the possibility of a contraction in the region’s oil demand this year against expectations of stability.
The relationship between falling oil prices and global demand growth is being redefined. The International Monetary Fund in a blog March 24 argued that cheaper oil at a time of slow economic growth, monetary policy exhaustion and deflationary pressures just doesn’t provided the “tailwinds” the world has come to expect of it. The producers meeting in Doha might want to take heed.
Vandana Hari is Asia editorial director at Platts and research scholar at McGraw-Hill Financial Global Institute