Battered oil sector awaits distant day of reckoning
It’s time for producer countries to tighten their fiscal belts
Crude plummeted to new lows not seen for a decade at the end of December to enter 2016 battered and bruised, as the market fixated on a stubborn and potentially worsening supply glut, and forecasts of a slowdown in world demand growth.
The gloom-and-doom view was reinforced by oil producers Saudi Arabia and Oman unveiling austerity budgets for the new year marked by hefty spending cuts, subsidy reductions, and tax increases.
News of China’s purchasing managers’ index dropping further in contraction territory to 48.2 in December sent global stock markets into a tailspin on the very first working day of the new year, suggesting growing worries over a slowdown in the world’s second largest economy.
On the supply side, attention turned to the lifting of nuclear sanctions on Iran, potentially this month, and the resultant new tide of crude barrels from that country. Though a senior official at the National Iranian Oil Company reassured that Iran would release the initial incremental 500,000 barrels per day (b/d) “gradually” so as not to provoke a further slide in prices, the mere prospect of additional supply hung heavy on a sentiment-driven market.
America lifting export restrictions on its crude as part of a government spending bill signed into law by US President Barack Obama December 18 was a historic move, but not one expected to have much impact on the global market in the near term, especially as the Brent-WTI spread had been consistently narrowing through the last quarter of 2015.
The spread, which flipped to negative for a few days following the US move, can now be expected to remain tight, which ironically, erodes the attractiveness of US crudes vis-a-vis competitive light sweet grades priced off Brent.
The export avenue is expected to provide little relief to US crude stock levels, which closed the year 37.5 per cent above the five-year average, and are expected to continue swelling in 2016.
A far more anticipated move, of the US Federal Reserve raising interest rates by a quarter of a percentage point at its mid-December meeting, was well baked in to the US dollar’s strength and consequently oil prices in the weeks preceding.
The latest forecasts by the International Energy Agency, Opec, and the US Energy Information Administration on average point to 1.28 million b/d growth in global oil demand in 2016, much below the estimated 1.57 million b/d average increase in 2015.
Oil demand in China, the world’s second largest consumer after the US and the biggest driver of growth for the past several years, rose 7 per cent year on year to an average 11.1 million b/d in the first 11 months of last year, but is expected to register a relatively pale 2 per cent increase in 2016, according to Platts China Oil Analytics.
India boasted a far hotter 8.7 per cent jump in oil demand in the first 11 months of 2015, but at 3.78 million b/d, its consumption is just a third of China’s and hence incapable of moving the needle on a global scale like its giant neighbour to the north.
US petrol consumption, which accounts for almost a tenth of world oil demand, created a lot of excitement at the beginning of 2015 with a major boost even before the driving season had kicked in, but averaged a tepid 220,000 b/d or 2.4 per cent estimated growth for the whole year to 9.1 million b/d.
Against this backdrop of faltering consumption growth, Opec stood its ground at its December 4 meeting, omitting even the mention of a production target in its communique, effectively disowning any notional ceiling on output.
Saudi Arabia, which persuaded Opec to defend its market share against rising non-Opec supply at the group’s pivotal November 2014 meeting, has consistently maintained output above 10 million b/d since March last year.
Russia, the other oil-producing giant, hit a new record high of 10.825 million b/d in December, helped by a 20 per cent jump in rouble-denominated upstream capital expenditure in 2015, and expects levels to remain flat in 2016.
The only sign of a receding tide right now is US production, which eased from a high of almost 9.7 million b/d in April 2015 to 9.3 million b/d in October, according to the latest available monthly EIA data.
The EIA expects 2016 output to drop to an average 8.8 million b/d from 9.3 million b/d in 2015 due to unattractive returns, companies retreating further into the core areas of major tight oil plays, and investment cutbacks reducing drilling rigs and well completions.
However, that 500,000 b/d decline is incapable of providing succour to a market overwhelmed by production continuing at full tilt elsewhere and brimming storages.
Importantly, it’s worth bearing in mind that any price recovery spurred by a major drop in US shale output is likely to bring that shut-in production right back on stream.
That points to two certainties: the market rebalancing is going to be far more drawn-out than most are imagining at this point – think years rather than months. Second, the price level that snuffs out substantial US output and the one that brings it back defines the new “equilibrium band” for the time being. It’s time for producer countries to tighten their fiscal belts.
Vandana Hari is Asia editorial director at Platts