Brent has recovered some ground since the start of the year, despite continued concerns over the state of the world economy.
In demand terms, the upturn reflects hope that the US-Chinese trade war is moving towards a resolution, and that the UK parliament will somehow avert a ‘no-deal’ Brexit before the looming deadline of March 29.
There are also grounds for optimism on the supply side.
Saudi Arabia appears to be acting on the agreement struck in December between OPEC and associated non-OPEC producers with determination. Secondary source estimates put OPEC production down 630,000 b/d in December from November at 32.43 million b/d, the lowest level in six months. Riyadh curtailed its own production by 401,000 b/d, acting one month before it is formally required to do so, with promises of more cuts to come in January.
Activity also appears to be stalling on the US oil patch. There was the sharp drop in the business activity index of the Dallas Fed energy survey for the fourth quarter, and the US rig count trended down in the four weeks to January 18, shedding 25 rigs in the most recently reported week to 852.
Nascent optimism surrounding the external trade environment is not misplaced, but neither an improvement in US-China trade relations nor the avoidance of a hard Brexit are done deals. Both still represent major uncertainties.
Chinese economic growth was reported in January at 6.6% in 2018 in line with expectations, but amid significant scepticism. China’s GDP data tends to hit government targets with uncanny accuracy.
Weakening industrial profits in the second half of 2018 implied a more significant slowdown than officially reported, although electricity demand ended the year up 6.8%, showing the strongest year-on-year growth in four months in December, according to China’s National Bureau of Statistics.
US benchmark West Texas Intermediate had followed Brent upward from its end of year slump to over $54/bbl by January 21. This may not be enough to reverse the apparent slowdown in new drilling activity, but may prompt US drillers to sell forward production from their voluminous stock of drilled-but-uncompleted wells (DUCs). The number of DUCs has been on a steady upward trend, rising 31% in the year to December when the US Energy Information Agency recorded 8,594.
Nor is compliance with the OPEC/non-OPEC agreement, which aims to cut 1.2 million b/d of production from October levels, a given.
While Saudi Arabia acted swiftly, other key producers were more prosaic, using December to maximise output ahead of the new restrictions. Russia hit a new production record of near 11.5 million b/d in December, according to the International Energy Agency. Iraq increased production to 4.67 million b/d, with record export volumes of 4.14 million b/d.
Saudi Arabia may find itself rather lonely when it comes to real action to curb output.
The additional falls in OPEC output in December were delivered unwillingly or inadvertently, an 80,000 b/d drop from Libya as a result of the closure of the Sharara field and a 170,000 b/d reduction in Iranian output as Tehran struggles to find buyers for its crude, owing to US sanctions.
‘X’ factor missing
Moreover, this round of production cuts looks unlikely to be flattered by steady falls in Venezuelan production. Although the country remains in the midst of a seemingly endless economic and social crisis, national oil output appears to have stabilised just above the 1.1 million b/d mark.
The Venezuelan ‘x’ factor is missing, and so far does not look likely to be fulfilled by sanctions-hit Iran. The US is expected in May to reduce the number of waivers granted in November, removing Italy, Greece and Taiwan from the list. However, this would not represent any real toughening of Washington’s stance as these countries are already thought to have stopped imports of Iranian crude.
This puts a huge onus on Saudi Arabia to more than deliver on its share of the cuts. It also underlines the increasingly pivotal role of Iraq.
Iraq’s importance within OPEC grows with every additional barrel of productive capacity. While the boom in US liquids production has understandably grabbed the limelight, Iraq’s steady increase in production has been significant, doubling in the last eight years, despite the violence and insecurity inflicted on the country by the Islamic State insurgency.
Iraq has the capacity to produce as much oil as Saudi Arabia in the long term, and while its medium-term production prospects are heavily circumscribed by its lack of storage facilities, export capacity and water to repressurise its giant fields, output can still rise in the short term towards its much-reduced and admittedly still ambitious target of 6.5 million b/d by 2022.
But Baghdad will not give up its expansionary trajectory lightly, and the federal government was not slow to fudge the figures during the last round of OPEC cuts.
Iraq then had its own internal x factor – the ongoing divisions between the Kurdish Regional Government and Baghdad. Here relations appear to be improving as a result of the shift in political balance following parliamentary elections in 2018. While many issues will continue unresolved, the transfer of federal funds to the KRG is stabilising the region’s finances, underpinning payments to foreign oil firms and thus allowing further investment in the KRG’s own oil fields.
The record export volumes in December reflected the recovery of both KRG volumes flowing to Turkey’s Mediterranean oil terminal at Ceyhan to 420,000 b/d and an increase from 9,000 b/d to 99,000 b/d in federal oil also moving north. But there is still shut-in capacity in the Kirkuk area and spare northern export capacity via the 700,000 b/d KRG pipeline.
In the south, production capacity runs the risk of curtailment as a result of the limitations on the southern export system, although some production will be absorbed by rising domestic demand. But spare capacity in Iraq that could be exported -- as a result of the Erbil-Baghdad rapprochement -- is a relatively new situation.
As a result, in the absence of further major falls in either Venezuelan production or Iranian exports, Iraq’s compliance with OPEC’s latest strictures on production is likely to move centre stage.
By Ross McCracken for Oilprice.com