As we expected, OPEC kept its production target of 30m barrels/day (b/d) of crude oil steady at its six-monthly meeting on November 27th. With global oil markets oversupplied, benchmark oil prices slumped on the news. Brent, the international crude grade, fell from US$76.8/barrel to just over US$72/b, and West Texas Intermediate (WTI) slipped below US$70/b, both having fallen well below these levels on an intraday basis. Prices have now shed nearly 40% from their mid-year highs and are on track to decline by at least 7% on average in 2014. With OPEC aiming to preserve market share, oil markets have taken a structural step down from their recent averages of around US$100‑110/b. In the short term, oil producers will feel the pain of weaker prices, but we expect long-term prices to edge back up thanks to emerging-market consumption growth.
Market speculation over OPEC’s course of action was split ahead of the meeting. We estimate that the group would have had to cut output by over 1.5m b/d in order to completely balance crude markets, roughly a 5% cut in total OPEC crude supply. Given the strained fiscal position of many of OPEC’s smaller producers, Saudi Arabia would have to bear the responsibility for much of the cut. However, the largest global exporter made it clear that it would not unilaterally take on the burden of balancing markets, and, with the support of its allies in the Gulf Arab states, faced down calls from Venezuela, Libya and others to bring down the production target.
OPEC’s intentions are never entirely transparent, but its motivation is likely to have been to preserve its long-term market share, even if this necessitated some short-term pain. The 12‑member bloc accounts for around one‑third of global crude oil supply (nearer to 40% if natural gas liquids are included) but will see some share eroded in 2014‑16 owing to fast-growing supply from non-OPEC nations, mainly the US and Canada.
Shale output will respond to fundamentals
US oil producers have demonstrated resilience in the face of recent price weakness, with government data showing crude output up to over 9m b/d at the end of November, its highest level since 1973. Thanks to production from shale oil fields, the US has managed to cut its dependence on foreign oil to just 46% of its available supply in September, from over 66% on average in 2007. While the US government maintains a ban on exporting most of its crude oil, the increase in US production has helped to add to global supplies via lower net imports (the US has lessened its demand on global markets from over 10m b/d in 2007 to less than 7.4m b/d as of September 2014).
But US shale output cannot remain immune from the vicissitudes of the oil markets forever. Low prices and higher interest rates will squeeze margins in 2015, and some smaller producers will face a liquidity crunch. Lower prices will lead to cuts in investment in new projects, and some existing fields will become uneconomic. We do not yet expect a contraction in production in 2015‑16, but downside risks dominate. Similarly, much of the growth in other non-OPEC supply is coming from expensive and technically challenging regions such as the Canadian oil sands and deepwater off Brazil or Russia’s Arctic resources (although, in the latter case, Western sanctions may play an added role in restraining development). Many of these projects were in the planning stages when US$100/b seemed to be the industry target, but will now come under greater scrutiny from investors.
On the demand side of the market, the current soft conditions are unlikely to persist in the long term. Consumption growth will continue to be led by the non-OECD world and there is significant catch-up potential among major Asian consumers to converge to the energy demand profiles of the developed world. We expect non-OECD oil consumption to increase by 20% from 2013‑19, compared with a decline of 2.7% in the developed markets. In order to meet that new demand, OPEC’s relatively cheap and easy-to-access oil will play a vital role.
Short-term pain seems assured
In the short term oil producers, whether in OPEC or not, will suffer in the wake of soft prices. Nigeria’s central bank weakened its target band for the naira and Russia’s rouble has hit record lows of close to Rb50:US$1. In Venezuela, lower oil prices, among other structural issues in the economy, have led foreign-exchange reserves to fall by more than 30% between January 2013 and late October. Libya and Iran will be among the OPEC members most exposed to the low prices, as production has been hit by civil war and sanctions. In the run-up to the meeting both had called for an OPEC production cut but will face an uncomfortable 2015 if oil prices fail to rebound substantially from their current levels.
Some of the Gulf oil producers will be able to ride out the price weakness owing to ample financial reserves. Saudi Arabia’s foreign reserves were close to US$750bn in October (enough to cover around three years of imports), while we estimate that Kuwait and the UAE hold over US$100bn in reserves between them (and considerably larger sums in their sovereign wealth funds).
But even here, governments are not immune to soft prices. We estimate that Saudi Arabia, the UAE, Iraq, Oman and Bahrain all have fiscal break-even prices well above current market levels. With heavy state subsidies and infrastructure investment programmes, the Gulf oil producers cannot survive low prices indefinitely. For some of the smaller producers, the break-even situation is even worse, with Algeria, for instance, requiring prices over US$125/b to balance its books.
Price outlook remains negative
Following the OPEC meeting, the short-term outlook for oil prices remains grim. The cartel itself described the market as “extremely well supplied” and expects another year of market surplus in 2015. Ahead of the meeting, we had expected some recovery in prices in the first quarter of 2015, but for annual average prices to show a decline of 13% from 2014 levels. A physical oil market surplus now seems assured for 2015, and with a relatively strong US dollar (which has historically depressed prices) there are few signs of support for oil in the next 12 months.
With market conditions firmly bearish, we will be revisiting our forecasts for the first half of 2015. OPEC has now ceded control of prices to the market rather than attempting to control them through supply-side constraints. Financial markets show no sign at present of easing their heavily negative sentiment against crude: on November 18th the US Commodity Futures Trading Commission “Commitment of Traders Report” showed swap dealers’ short positions for WTI contracts traded on the NYMEX outnumbering long positions by nearly 3 to 1. Such negative sentiment, and a large net short position, traditionally presages a recovery in prices. We still anticipate some snap back and do not expect prices to stay in the US$60‑70/b range for an extended period, but it seems clear that prices have entered a much lower trading range than their post‑2011 bracket of US$100‑110/b.