Oil prices have bounced around in the week following the OPEC+ agreement, and the IEA says that the deal may have at least put a floor beneath prices. However, volatility is unlikely to go away.
There are a litany of variables that will have enormous impact on oil as we head into 2019, on both the supply side and the demand side, both bullish and bearish for prices.
The bullish factors
Iran. The largest and most obvious risk to supply comes from Iran. The U.S. waivers to eight countries buying Iranian oil will expire in May. With Brent crude above $80 per barrel as the November deadline approached, the Trump administration grew skittish and issued a series of waivers after spending most of the year blustering about how serious it was about taking Iranian oil to zero. It would seem unlikely that the Trump administration would want to repeat that scenario, and with a supply surplus suddenly exploding in the last two months, the U.S. government has more leeway to take a harder line. Iran’s production fell by 380,000 bpd in November from a month earlier, dipping below the 3 million-barrel-per-day mark. There is still a lot of supply that could be disrupted, and if the U.S. succeeds, OPEC+ may find that it accomplished much of what it set out to do in Vienna by mid-year.
Libya. Libya just lost 400,000 bpd because of militia activity, after successfully ramping up supply to multi-year highs just a few weeks earlier. The North African OPEC member has been a source of supply instability for years, and although the country has lofty goals to increase production in 2019, it is just as likely that they could surprise the oil market with unexpected losses.
Venezuela. Venezuela is set to close out the year near 1 mb/d of output, down more than 600,000 bpd since January. The losses could slow at this point, if only because there is little left to lose. Yet, one would be hard pressed to find a single analyst that expects production to rebound in the near- or even the medium-term.
U.S. shale. By all accounts, U.S. shale is expected to continue its explosive growth. Indeed, shale producers have vastly exceeded 2018 forecasts, surpassing some initial estimates by around 1 mb/d. It is all the more notable since the drilling frenzy was supposed to be hobbled by pipeline bottlenecks. Nevertheless, the recent downturn in prices, financial stress and ongoing pipeline issues could finally slow growth. Nobody is expecting production to decline or even flatten out at current levels, but because so many pricing scenarios factor in huge growth from U.S. shale, even a mild disappointment could tighten balances more than expected.
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OPEC+ cuts. The 1.2 mb/d cut should help eliminate much of the surplus, although perhaps not by the mid-year meeting in Vienna. OPEC+ might be forced into extending its production cuts. But formulating a deal to begin with was the hard part. The group can simply extend the deal through the end of the year to ensure prices do not go any lower.
Lack of supply growth. This is more of a post-2020 problem, but the severe cutback in spending that began in 2014 has not really been felt yet. The surge in shale supply has papered over the dearth of new conventional projects. With the pipeline of projects drying up from 2020, supply tightness might start to pinch. The most recent downturn in prices might result in another year of (relatively) low spending. “A fifth year of low global conventional spend and cherry picking the best projects leaves hoppers increasingly depleted,” Wood Mackenzie’s Chairman and Chief Analysts Simon Flowers said in a report on Thursday. “The retreat in oil price likely nips in the bud any urge to relax capital discipline.”
Bearish supply-side factors
Economic downturn. Perhaps the largest pricing risk, and one of the hardest to predict, is the possibility of an economic downturn. The global economy has already thrown up some red flags, with slowing growth in China, contracting GDP in parts of Europe, currency crises in emerging markets and financial volatility around the world. The tightening of interest rates looms large in many of these problems. “Alarm bells are starting to ring. Demand growth has been a pillar of strength for the oil market since prices fell and has exceeded 1 million b/d every year since 2012,” WoodMac’s Simon Flowers wrote. “We forecast 1.1 million b/d in 2019, but the trend is at risk.” The U.S.-China trade war could still drag down the global economy, but financial indicators are already flashing warning signs.
U.S. shale growth. Despite a downward revision compared to a prior forecast, the IEA still expects non-OPEC supply to grow by another 1.5 mb/d in 2019, which exceeds total global demand. The bulk of that will come from U.S. shale. With new pipelines coming online in the second half of the year, the next shale wave could be coming.
OPEC+ noncompliance. Already Russia has indicated it would not cut by much in January, when the OPEC+ deal takes effect. As such, there is a risk that the full cuts do not materialize. Saudi Arabia will do most of the cutting, and since it desperately wants higher prices, it should follow through with significant reductions. However, there is still uncertainty on whether or not OPEC+ can complete the job of balancing the market.