By Syed Rashid Husain
IN sharp contrast to last year, this New Year has begun on a positive note – as far as the energy market sentiments are concerned. When 2016 began, oil prices were on their way down – touching the ebb of $26.05 a barrel end February. The market share battle was on. A flicker of hope was seen around the Doha moot in April 2016. But that too evaporated, soon.
2017 seems to have a better and more positive beginning. Prices have firmed up. Courtesy the OPEC deal of Nov. 30, followed by the Dec. 10 OPEC–non-OPEC deal in Vienna, crude market sentiments are positive. Markets have reacted positively to the output cut - the first in eight years.
How would the oil markets fare this year? A billion dollar question - with too many variables to account for. Yet some consensus seem emerging. Volatility is all but certain - most now seem underlining. Producers, OPEC and non-OPEC alike, face a new balancing challenge in 2017: boosting prices without igniting shale.
The agreed output cuts set prices surging upward, surpassing the $50 threshold for the first time in many months. “OPEC is aiming for a much-needed lift to the oil price, given the stretched fiscal balance sheets of every (crude) producing nation,” Ed Morse, head of commodities research at Citigroup, was quoted as saying. A major challenge to the agreement could come from the dozens of US drillers who survived the rout by becoming leaner and more efficient. “The question really should be what happens afterward - how fast is US shale going to come back?” Morse argued.
After three years of turmoil, there are already signs of a rebirth in America’s shale fields as prices have risen and stabilized at around $50. If they jump by another $10, shale output that’s now at 4.5 million bpd could quickly rise by 500,000 barrels, Morse wrote in a December 22 research note.
At 8.8 million barrels a day, the US is already pumping almost as much crude as two years ago, with just a third of the rigs it operated at the peak. Since May 2016, drillers have added about 200 rigs, taking advantage of rising prices as talk of an OPEC supply cut circulated.
A bigger boost in prices could mean a million-barrel shale surge from the US, Macquarie Research analysts noted in a Dec. 12 report to clients. That would all but obliterate the cuts OPEC agreed to in November.
Could all this be ominous for the crude markets - a big if indeed? Many do feel so.
Other challenges too, haunt the markets. Producer’s effort to balance the oil markets could also be impacted adversely, because of the crimping crude demand from China, Matt Smith, head of commodities research at shipment-tracking firm ClipperData was quoted as saying.
Cutting production has boosted prices, and that could result in less strategic buying from China, according to Smith. “Emerging market demand, and specifically from China, has been really strong in 2016,” he told CNBC’s “Squawk Box” on Tuesday.
“However, they’ve been on these sort of bouts of bargain hunting and opportunistic purchases to essentially fill their stockpiles, their strategic reserves. And so, as prices rise, and as they’ve risen recently, we’re likely to see less of that bargain hunting next year,” he said. And thus, if Chinese oil demand falls in the face of rising prices, it would make it harder to reduce crude inventories.
In the meantime, the US Department of Energy could begin to sell off some of its strategic petroleum reserve (SPR) as soon as January. And this could impact the markets negatively. US policymakers do not seem much concerned about the security of oil supply for the US economy. It has the authorized the DOE to sell off $375.4 million worth of oil in its recent budget resolution. The DOE said that such a sale could be held in January 2017.
Various pieces of legislation have put the US on a path to sell off 190 million barrels of oil from the stockpile gradually over the next decade. The sales are slated to take in $2 billion by 2020 to finance maintenance.
While these volumes are not huge, they might add pressure to prices, some say. “The sales of SPR oil could temporarily curb incentives for barrels in Cushing to flow to the U.S. Gulf Coast,” Barclays analysts recently said. The oil could reach the market in March or April, just “as refineries exit their turnabouts, but that could still steepen the WTI contango,” analysts added.
Markets are also keenly monitoring the level of compliance with the agreed output cuts. The group’s members “tend to cheat,” former Saudi oil minister Ali Al-Naimi said in a speech Dec. 2 before the agreement between OPEC and non-members was finalized.
He also expressed skepticism that Russia, considered a wildcard during talks, would follow through on its promise to reduce its output by 300,000 barrels a day. “Will Russia cut?” Al-Naimi asked. “I don’t know. In the past, they didn’t.”
This could be a real issue. But producers appear serious this time - for they know in case they fail, results could be disastrous. In order to ensure compliance, the OPEC and non-OPEC producers committee, formed to monitor the market and compliance is now expected to meet on Jan. 13. Oil markets rallied after news of the meeting emerged, as it gave an indication of their seriousness toward the deal.
In the meantime, threats from within too, continue to haunt. Nigeria and Libya got exemptions because conflicts in both countries damaged their output. If each nation reached its potential this year, then their additional barrels would almost wipe out the producer group’s supply cuts.
If Brent hits $60 or more, producers should be watched carefully for signs of backsliding, but initial compliance should reduce global inventories slightly.
Analysts are thus bullish early, bearish later.
Analysts at Barclays see WTI prices averaging $56 in 2017, up from $44 over 2016 as the proposed cut could go deep enough to spur activity in US shale basins that would ultimately push prices back down in the second half of the year. “The strategy is bound to overshoot, in our view, leading to higher tight oil production and lower oil prices in the second half of next year,” the analysts said in a Dec. 12 research note.
“Oil exporters subject to the recent OPEC and OPEC/non-OPEC accords still need to contend with a litany of bearish factors in the coming weeks,” Citi analysts said in their Dec. 19 research note. Citi Group sees WTI prices averaging $55 over 2017, ending the year at $62. They say that because the agreement depends on average output over a six-month period, the true extent of the cut won’t be known until well into the year. They but expect the prices to drop in January as doubts mount over whether countries will comply with the quotas.
Markets are not settled, yet. Too many ifs continue to haunt the sentiments – at this time of the year.
