Global oil markets are still not stabilized. After a week of price shocks, in which analysts have suggested that crude prices could be hitting the $40 per barrel mark soon, prices are up again. Analysts are still not able to predict markets, with exception of Tanker Trackers or ClipperData. The media continues to hit on OPEC, questioning its overall power. A bearish sentiment rules the sector while traders seem to not be paying any attention to global developments, such as the growing willingness of OPEC and non-OPEC producers to extend the production cuts. The geopolitical risk premium (after the missile attack on Syria) seems to be absent in the majority of the analyses, something which is totally out of order when looking at the current geopolitical situation in the MENA region or North-East Asia.
By painting a bearish environment, which is not based on facts but rather on the already very questionable gut-feelings of the financial sectors, bulls have been put in a corner or are hiding behind closed doors. This could be changing very quickly, as fundamentals are stabilizing, and geopolitical risks increase. Trump’s erratic behavior, combined with Putin’s power projections or North-Korea’s warmongering, should be enough to put a risk premium on crude oil and gas (LNG) than currently is the case. The heating up of the Saudi-Iranian conflict also seems to reach its zenith.
Still, the market is watching OPEC’s struggling production cut impact on the market, based on historically high storage volumes in the U.S. and other OECD countries. It looks as if all analysts have become Calvinists, “The Glass is always half empty”. Reality shows that we have come from a much more detrimental situation, where the glass was almost empty, now the adagio should be “The Glass is half Full”.
Even that OPEC’s optimism, as presented by Saudi Minister of Energy Khalid Al-Falih at Davos in late January, when he stated that the OPEC production cut agreement as working so well cuts could be phased out in June, has not yet materialized fully, the green sprouts (of the impact of the agreement) have already grown into a young tree. Yes, U.S. shale oil has partly shredded a possible OPEC cut phase out, but so far, this has not resulted in higher (floating) storage volumes worldwide. This week’s EIA report surprised the market, as the latter reported a much higher than expected stock draw of U.S. storage volumes than expected. On 10 May the EIA said U.S. inventories fell by 5.2 million barrels last week vs. the 1.8 million barrel decline analysts expected. Crude oil prices veered back again.
Market sentiment (especially among hedge funds) remains negative, even after crude prices rose and stocks drew lower. Bloomberg reported that OPEC should be digging in for a long war of attrition against shale. The latter could be partly true, if U.S. shale operators and investors are able to counter increased drilling rig costs, higher material costs and a strong need for continuing investments. The count on this is however still out, as reports are emerging about price pressure.
An attrition war, which will be costly for both sides, could be in the offing. OPEC and major non-OPEC producers, such as Russia, should be bracing themselves for a continuation of the current production cut strategy for a pro-longed period of time, for sure into 2018. There has however been a major change in risks for both sides. When Saudi Arabia started its “War on Shale”, the Kingdom did not expect the costs be as high, but reality has hit them hard. After several years of struggling, Riyadh and a majority of OPEC members have understood that times have changed permanently. The oil market has become really global, shale has pushed the U.S. back into the lead. A war of attrition the coming years will not be impacting Saudi Arabia as much as it did two years ago. Structural changes in spending patterns of the Arab governments and drive for economic diversification has made countries such as Saudi Arabia and the UAE, more resilient to crude oil price pressure. At present, the Kingdom and its Gulf counterpars are more able to keep pressure on shale oil than ever before. The last financial reports on Saudi Arabia, UAE and Kuwait are showing much lower budget deficits already.
The main risk for non-U.S. producers (OPEC-Russia) is not production volumes, but the role of financial institutions. As was the case in 2014, shale oil producers have been hedging heavily for 2017-2018, or even 2019. The latter will give U.S. shale oil enough breathing space to continue the current surge no matter what other oil producers will do. The real confrontation between OPEC (and Russia) and shale is expected to be in 2018. Costs could be high, it seems now a question of “who will blink first”.
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In the meantime, the production cut agreement extension is gaining ground. OPEC and Russia have openly discussed a potential production cut extension. Other Non-OPEC producers, such as Turkmenistan and Azerbaijan have also expressed support for an extension. Around 1.8 million bpd will be removed from the market, making enough room on the market to counter the expected 1 million bpd of additional shale oil from the U.S., combined with possible additional volumes from Canada and Brazil, there is still a drawdown of stocks in place. World oil demand growth for 2017 has been left unchanged by OPEC in its MOMR this week at 1.27 million bpd.
The above mentioned bearish market picture could change dramatically in the near-term. OPEC’s 25 of May meeting is also surrounded by some possible surprises. Saudi Arabia has been very active lately to get other non-OPEC producers to join the production cuts. A possible change of approach by these parties could also be in the offing. The current agreement is a production cut, even if media always seem to look at it as if it was an export cut. OPEC sources and analysts are currently addressing the options of changes in the deal that would turn it into an agreement that includes also petroleum products and NGLs. The latter could dramatically change the overall picture, even for the U.S, markets, where OPEC members have an ever growing say in downstream operations.
At the same time, still not assessed fully by most, geopolitical risks are increasing. The King Salman-Deputy Crown Prince Mohammed bin Salman – Saudi Minister of Energy Khalid Al Falih power triangle has been able to set up cooperation with Washington. President Trump’s visit to Saudi Arabia is not coincidental, there are several reasons why Trump and King Salman will convene during the OPEC meeting on the 25th. Three reasons have been put forward already in the press, multibillion arms deals, the Iran issue and the Aramco IPO. Mohammed Bin Salman already has openly stated that international arms deals with the Kingdom will have very strict conditions attached to it. The listing of the Aramco IPO on the New York Stock Exchange is currently another boon that Trump would like to get. Also here are major strings attached. Taking a devil’s advocate approach, trying to look into the mind of the Deputy Crown Prince Mohamed bin-Salman, one big string could be a link between the Aramco IPO and arms deal on one side and a more pro-active support of the Trump Administration for a U.S participation in the OPEC-Russia production cut agreement. The latter has already been called for by Saudi Arabia several times.
When looking at the Iranian issue, which could have a major impact on oil prices and production, the fact that Trump is visiting Saudi Arabia at the same time that King Salman has called for a meeting of the Islamic Military Alliance (IMAFT) is not coincidental too. The U.S. president has been even invited to attend, together with President Sisi of Egypt, Turkish President Tayyip Erdogan and the Pakistanis. A military strategy or action against Iran could be in the offing, including U.S. military support.
Taking these issues while assessing the global oil market, a growing list of lights are on green/orange indicating a possible price rally. It is just a question of time (most probably just before 25th of May) that the first sprouts of a price recovery will show. Trump’s statements and actions could be the final push to see oil reach $60.
By Cyril Widdershoven for Oilprice.com