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$1 Trillion Money Manager Downplays The OPEC Deal

Asset management group PGIM warns…

Peter Tertzakian

Peter Tertzakian

Peter Tertzakian is Chief Energy Economist and Managing Director at ARC Financial Corp., Canada’s largest energy-focused private equity firm. His career began as a geophysicist…

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Is There Enough Pain To Force An OPEC Deal

Lifting at a rig

Where is all this oil coming from?

Millions of barrels of excess crude oil are weighing down tankers that are being filled from pipelines coming from fields where rows of overworked pump jacks are bobbing their heads up and down like spooked horses.

Oil markets are spooked again too.

In the absence of output restraint – a return to some sense of prudent resource management by the world’s largest state-owned producers – oil prices could submerge below the industry’s $40/B Plimsoll line for the second time this year.

It should come as no surprise that the glut is largely being produced out of the Middle East, where this mother of all price battles began over two years ago.

Year over year, up to the end of the third quarter of 2016, output from the oil-rich region is up by almost 2.0 MMB/day (see Figure 1). Iran, Saudi Arabia, and Iraq have been the most aggressive about ramping up their flows. Kuwait and the UAE are also pumping more.

Russia, though not part of the region, nor a member of the OPEC cartel, seems content to over-satiate the market too. Being paid in US dollars for their oil, a half-price, sanction-laden Ruble makes the Russians quite happy to join the fray.

Then there is Libya and Nigeria. Both are unpredictable. Recent news suggests that the two appear to be cranking their valves open again. That spooks the market too – at least until the next time rebels blow up their infrastructure.

It’s not likely that oil will flow out of the ground much faster next year without greater upstream investment. But that isn’t much consolation. Left unchecked (i.e. no agreement at the next OPEC meeting) the strained volumes that are being put into white storage tanks around the world now will continue to pressure prices well beyond 2017.

By any business measure, this price war should have been over by now. But oil is not a business like airline tickets, pizzas or inkjet printers.

Many decision makers behind the world of deep holes, silver pipes and black barrels do not strategize with game theory. No spreadsheet captures geopolitics, grudges, spite, religious conflict, or survivalist instinct into the calculus of how much oil to pump out. For countries with warring regions, there isn’t any textbook notion of cost curves or break-even economics; just selling more oil at any price liberates badly needed cash.

Related: How Trump Can Help OPEC Reach Its Production Quota

In the absence of common business sense, the fiscal pain of this downturn is biting the entire global industry hard. Third quarter, 2016 financial results from global super majors prove the point.

The likes of ExxonMobil, Chevron, BP, et al, have disclosed again how costly this downturn has been. Cash flow among these players has been de minimis from upstream operations this year, especially in Q1 when the price of a barrel was trading below $40. Average capital spending for the group has now been slashed to almost 50% below peak 2013 levels. Production is flat to declining. Tellingly, even after two years of aggressive cost cutting, innovation and productivity improvements, the largest of these independent oil companies (IOCs) have to keep taking on more debt and selling assets to cover their coveted dividend payments.

If the best run companies in the oil world can’t make a buck and grow, which operators can? Most national oil companies (NOCs) aren’t making enough money to cover their host country’s “social costs,” which is a polite way of saying they are running up massive fiscal deficits. At the state level, the overproducers are fiscally weak too. So much so that the International Monetary Fund (IMF) recently projected that the cumulative fiscal deficit among the Gulf Cooperation Council (GCC), Caucasus and Central Asia (CCA) oil exporters, and Algeria could reach about $340 billion over the next five years.

Related: Can Trump Send Oil Prices Soaring?

Mega fiscal deficits, for IOCs or NOCs are not sustainable. Eventually the production volumes from every region will go into decline from lack of cash flow and re-investment. Producers like Mexico, Colombia, Venezuela and even the United States highlight that point in Figure 1. Canada appears to be growing, but that’s only because of the lagged output from prior investment.

(Click to enlarge)

The next OPEC meeting is scheduled for November 30th. With price in the low-to-mid-forties there is already talk of a deal again (of course!)

“No pain, no gain,” is an adage that can be applied to fighting for market share. So maybe the best thing that can happen before November 30th is for oil prices to scrape lower again to a threshold of pain that may finally motivate a deal for collective gain.

By Peter Tertzakian for Oilprice.com

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  • Bud on November 17 2016 said:
    Good piece, but you need to show a chart of the same period 2014-2015 to provide a fuller picture. The U.S. And Canada were on a drilling tear and on pace to drill about 50 thousand oil and gas wells in 2014 and the Saudis decided to increase production by nearly a million bpd into that massive wave. why?

    They waited for the fed to change course and then hit the market hard, as much to punish the financing of the glut, as the producers themselves. With sec reserves pricing formulas flattened they will be putting more pressure on offshore drillers and other long lead projects, OPEC or not, rather than west Texas.

    Knowing the aramco reserves position would help since they could afford to tank prices again this winter if they can confirm numbers anywhere near the 250-300 billion prior to an IPO. If the numbers are closer to 150 or less, which some suspect, they will need oil closer to 90 pre IPO. The latter scenario would reignite global oil investment as the wider world would realize the gig is up by 2040-2050. This would be counter productive, so one would suspect they will show a higher number, but can they go public in New York with made up numbers? The guess is they will issue in a non eu london, if at all.

    And of course the other OPEC members know all this, and when the Saudis pressure them they must point to the near 2 million bpd increase in Aramco production since 2013. The path of least resistance would be to do nothing and allow prices to tank again, sending more firms into chapter 11 and consolidation..by 2019 the market would likely balance on its own.

    The wrench is Trump, who could easily ban imports on OPEC oil, and thereby break up the cartel. Things get complicated at that point, but clearly he will have much leverage with the talks between the Saudis, Russians, China and Europeans as to how the planets energy industry will be run and divied up.
  • RICHARD YHIP on November 17 2016 said:
    Thanks Peter,

    You summed it up pretty well! Regards to the forth coming OPEC meeting Nov. 30, given the past history of discontent among the members I have little to no confidence they will agree on a cut in production. Even being optimistic there will be a cut... however small, the distrust among the OPEC members to ensure individual compliance is in serious question..."how will they do it?" I feel since their announcement of cuts several weeks ago they have been toying with market sentiment with Russia playing the "Devil's Advocate" making sly remarks to guide oil prices in their favor. With Trump as President I suspect he has no interest in environmental concerns & will further the cause for American oil dependency over foreign oil...& that perhaps includes Canadian oil further aggravating the oil dilemma today and into the future.
    Hopefully at some point the world will either increase it's demand or else run out of ideas for storage!

    US and Canada should recognize that the world is at the "point of transition"...meaning we need to seriously wean ourselves from the dependency of oil. It served us well for decades but we are wise today (at least some!) and knowledgeable enough to realize it has a deleterious effect on the planet. The "old school" thinking needs to be set aside with the highest priority given to developing "cheap & efficient renewable energy"...if the world must survive. The world cannot continue to be blind & not recognize the power of natural energy...after all mother nature gives us that "clue" every day! Why are some so blind? It only needs to be tamed to work for our benefit! Mankind has proven when not destructive to be innovative...& we can do it! Everything comes with a price (even success!) but the earlier we start the faster we will overcome our energy problems but the world leaders must recognize this importance ... & that could be a problem.

    Thanks for taking the time.

    Richard Yhip.

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