By Syed Rashid Husain
From the ashes of the old order, a new global energy order is emerging. And its emergence is now being felt - all around.
OPEC’s overall compliance with output cuts, agreed last November, has gone up in February to 94 percent, up from 86 percent in January, a meeting of OPEC technical committee concluded. This is simply unprecedented!
Yet, crude oil markets continue to feel the heat.
Mid last week, oil closed at the lowest level since November, after data showed US crude inventories rising faster than expected. Futures dropped 1.8 percent in New York. Pressure piled on OPEC as this erased the gains that followed the November output cut deal.
The Brent followed, touching below $50 a barrel on Wednesday, for the first time this year, as the US crude inventories reportedly climbed to a fresh record, raising fears that OPEC’s attempts to tighten the market are falling behind.
As per an Energy Information Energy report, the US crude inventories rose by 5 million barrels to a record high of 533.1 million barrels in the week ending March 17. Many saw it as a clear indication of a rebound in US shale output, blunting the market tightening efforts of the OPEC.
The rise in US crude stocks comes as shale drillers ramp up efforts, once the rebound in prices, due to the OPEC output cut, relieved the pressure on their balance sheets, which had been hard hit by the two-year slump. US drillers have added rigs for nine straight weeks, leading analysts to revise up their forecasts for how much the country might produce this year. That poses a challenge to OPEC.
With growing US output and the increasing crude inventory, shale continues to influence the markets in a big way
This all is heaping pressure on OPEC. In order to control the markets, OPEC will have to do more, by either increasing the output cuts or rolling it over the initial six-month cut period, analysts are now underlining.
For the moment, markets are jittery. They don’t seem to be holding on to the optimism seen until recently. “OPEC’s market intervention has not yet resulted in significant visible inventory drawdowns, and the financial markets have lost patience,” US bank Jefferies said in a note.
“There are growing doubts among market participants about whether the OPEC production cuts will be able to quickly restore balance on the oil market,” Carsten Fritsch at Commerzbank was reported in the press as saying. “[The cuts are] still failing to drive down stocks.”
Increasing shale output is balancing out the OPEC cuts to a great extent. And the pessimism is not only short term - but it seems to extend beyond. New production projects and a fresh shale boom could boost oil output by a million barrels bpd, year-on-year, and result in an oversupply over the next couple of years, Goldman Sachs reported.
«2017-19 is likely to see the largest increase in mega projects› production in history, as the record 2011-13 capex commitment yields fruit,» the US investment bank said in a research note last Tuesday. The delayed delivery of the 2011-13 capex boom could lead to record non-OPEC production growth in 2018, it added.
OPEC›s output cut decision has unintentionally helped the shale producers, the bank said. In the emerging New Oil Order, Goldman points out that OPEC›s role has structurally changed - from a long-term price setter to inventory manager.
Goldman says, in the past, large-scale developments required seven years plus from Final Investment Decision to peak production, giving OPEC long-term control over oil prices. However, US shale oil currently offers large-scale development opportunities with 6-9 months to peak production.
This short-cycle opportunity has structurally changed the cost dynamics, eliminating the need for high-cost frontier developments and instigating a competition for capital amongst oil producing countries. It is lowering and flattening the cost curve through improved contract terms and taxes.
All this means OPEC is in a tight corner. If it extends the output cut at its scheduled May meeting, the possibility of shale output continuing to be strong remains valid and markets could stay volatile.
Major stakeholders also don’t appear optimistic. Policymakers in Moscow were reported as saying on Friday, they see the Urals at an average of $50 a barrel this year, but falling to $40 at end-2017 and then staying near that level in 2018-2019. Ural blends generally trade at little below the Brent.
Goldman also underlines it, pointing to the dilemma the OPEC is faced with: should it extend the production cuts to prevent prices from falling further – (it will) invite US shale to come in fuller force - or it would let them fall to avoid the risk of losing long-term market share.
Despite the fact that while opting for the output cut agreement last November, many within the OPEC gave up the market share battle - at least for the time being. But with the changing scenario, the markets share battle could not be ruled out - for eternity.
But it also brings to fore another issue - that of market control.
Who really controls the market? In the changed circumstances, to what extent OPEC can influence the markets? Things have definitely changed. OPEC is not the sole player. Others in the market now have a say and indeed influence over the markets. The growing shale output is impacting the global energy order in a considerable way.
After the disastrous results in the mid-80s and early 90s, Saudi Arabia gave up the role of the sole swing producer of the world. Yet many felt that with its spare capacity, if anyone could alter the market conditions, it was OPEC - courtesy - Riyadh.
That may not be the full truth these days. With Riyadh no more having the appetite to play that role any further, US shale has emerged, many insist, as the new swing producer on the global energy horizon. In these changed circumstances, OPEC may not control and influence the markets alone. It needs to work in tandem with producers outside the group - to achieve the desired results. Russia is definitely one of them. But the United States is now an important player and without it on board, for OPEC to influence the markets in a big way, seems difficult. Indeed OPEC has been successful in bringing Russia on board. Yet, the US also needs to be on board.
This decision to be on board with OPEC and Russia has to be taken at the top political level in Washington. This is beyond the DoE. Maybe a business-friendly Trump administration could prove to be more amiable on the issue than the previous administration.
The growing bonhomie between Trump and Deputy Crown Prince Mohammed Bin Salman could prove to be helpful in this direction. Who knows?
