Last week, oil prices hit their highest level since late 2014 on the back of continued global and U.S. stockpile drawdowns and expectations that oil demand growth will stay strong this year.
Analysts and officials are once again trying to predict what a ‘fair’ price for oil is – a prediction that must take into account the summer driving season, the possibility of new sanctions on Iran, elections in Venezuela and Iraq, continuous OPEC chatter about “mission accomplished or not”, and reports of OPEC kingpin Saudi Arabia aiming for oil prices of $80 to $100 a barrel.
Some analysts and officials believe that oil prices could hit $80 this year, although such a price would probably be due to the geopolitical risk premium rather than market fundamentals.
Even if oil prices were to rise to $80, such an increase would be short-lived, and would be mostly fueled by fears of a supply disruption, especially in the Middle East with possible new sanctions on Iranian oil and with tenser situations in and around Syria and Yemen. Then there’s Venezuela, with its oil production plummeting and elections expected to be held in May—and if the U.S. were to slap further sanctions on Venezuela, such as on its oil industry, it would be yet another wild card for oil prices later this year.
Yet, around $75 oil is as good as it’s going to get in the short term, according to some investment banks and oil officials. No one is predicting oil at $100 yet.
“I think $65 to $75 is more realistic numbers for the rest of the year, but there are so many factors that can change that,” Mohammed bin Hamad Al Rumhi, the oil minister of non-OPEC participant in the production cut deal, Oman, told CNBC.
“In my opinion, where we are is not too bad and we can live with it. That’s $65 to $75, give or take, for the foreseeable future,” said the minister.
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According to Alexander Novak, the Energy Minister of the non-OPEC leader in the pact—Russia—oil prices could reach $80 a barrel as early as this month, although such a price would not be justified by market fundamentals, but by geopolitical concerns.
Bank of America Merrill Lynch and Goldman Sachs, for example, expect oil prices to hit $80 this year, with BofA Merrill Lynch expecting this to happen this quarter, due to some bottlenecks emerging in the Permian that could slow down the growth pace.
Goldman Sachs sees strong oil demand growth in 2018, with its 2018 year on year growth estimate at 1.85 million bpd. The first quarter that has just ended is likely to have posted the strongest annual growth since the fourth quarter of 2010, according to Goldman.
Barclays sees upside pressure on oil prices this quarter, but expects the price of oil will go into correction in the second half of 2018 due to surging U.S. production, overrated concerns over renewed Iran sanctions, and Venezuela production drops, which are already priced in.
Yet, the upside pressure of geopolitical concerns amid the tightest market in years could tip the scales into oversupply again, as higher oil prices would encourage more U.S. shale areas to pump at profit, and could also weigh on demand growth.
But U.S. shale faces “production challenges”, the largest oilfield services provider Schlumberger said on Friday. Those challenges could slow the growth pace of the U.S. supply.
“However, production challenges in US shale are emerging that are linked to infill drilling well-to-well interference, the potential lower production of step-out drilling from Tier 1 acreage, and significant infrastructure constraints,” chairman and CEO Paal Kibsgaard said in the Q1 results release.
On the demand side, the higher the price of oil, the higher the gas price at the pump. This summer, drivers in the U.S. will pay an average of $2.74 per gallon of regular gasoline, 11 percent more than last summer, the EIA says. These prices are expected to be the highest average gas prices in four years, largely reflecting changes in crude oil prices, the EIA has estimated.
At a theoretical $100 a barrel Brent—a level that Saudi Arabia would reportedly love to see—demand growth would be seriously affected.
The uptick in oil prices could lead to a slight drop in demand, Total CEO Patrick Pouyanne warned last week.
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Yet Saudi Arabia signals it is willing to continue to tighten the market this year, despite the inventory drawdown to the five-year average within sight or perhaps even achieved.
Saudi Energy Minister Khalid al-Falih told CNBC on Friday that the mission is not accomplished and that OPEC was working to identify the metrics and “calibrate” the target of the cuts—they are now openly admitting that the goalposts would be moved to justify the cuts through the end of 2018, as planned.
Even if oil prices spiked on geopolitical concerns, above-$75 a barrel price would not be sustainable because it would bring in new non-OPEC supply (and it’s not only the Permian that would be pumping) that would tip the balance to overhang again, and because it could start eroding demand growth that has been robust over the past year.
By Tsvetana Paraskova for Oilprice.com
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That said, let us all recall early 2016 when the Saudis said they can pump at $10/bbl and still be profitable. True or not, many seemed to believe it at the time, as WTI sank to $26.05 but quickly went back to the $30s. Then U.S. shale said "Just give us $40" and the market did just that. Also all in 2016, WTI broke a "psychological barrier" of $50/bbl. Yet, OPEC decided that was't enough so they agreed to production cuts starting in 2017.
In early 2017, prices remained high as EIA reports were recalculated to not include offshore tankers. But nonetheless, U.S. shale still flooded the market with weekly bearish data on API, EIA, and Baker Hughes oil rig count reports and oil was back in the $40s (actually, a 'flash crash' occurred the last time we had record long positions via algorithmic trading on behalf of hedge fund managers). Also, OPEC learned a lesson after prices plummeted during their mid-year meeting last year, so by late 2017 they decided to continue production cuts through 2018 and BOOM! Goodbye $40s...farewell $50s too.
$60 as a floor for WTI and $65+ for Brent was thought to keep U.S. shale afloat and thriving and by way of weekly rig count data, that seems true. But now with WTI nearing $70 and Brent close to $75 that still isn't enough for the Saudis. Iran says it may be enough and Russia's oil minister Novak has repeatedly stated that "Russia can survive on $40 oil forever".
The Saudis want $80 to $100 but the world cannot sustain that, even if prices hit that far. There are enough other sources of oil from U.S., Canada, Brazil, and Norway...not to mention various members of OPEC that will either cheat or exit the deal before then. Every alternative to oil will be greatly accepted and oil will fall. Thus, $60s are a fair price.
One has to differentiate between an opportunistic oil price and a fair oil price. Oil producers around the world should be guided by a sound economic principle meaning they should always try to maximize the return on their finite assets aiming for the highest prices the global economy could tolerate. This price could be anywhere between $70 and £130 a barrel. If oil prices rise too high, the oil market fundamentals will tell us in no uncertain terms and will take corrective measures as happened after oil prices reached $147 in 2008.
As for a fair price of oil, one can’t place a price on the blood of the global economy. Still, my research indicates that a fair price ranges from $100-$130. Such a price is good for the global economy in that it enhances global investments, it improves oil producers’ revenues thus enabling them to explore more for oil and expand oil production capacity to meet future global demand and it enables major oil companies to balance their books and resume investing in oil and energy projects. We have seen how the oil crash of 2014 very adversely impacted on the global economy.
Geopolitical concerns could add $1-$3 to a barrel of oil unless there is a supply disruption in a major oil producer such as Venezuela, Saudi Arabia or Iraq. Then we may add $10 or even more to a barrel. This is not yet the case.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London
What other non-OPEC supply are you seeing with $75 oil? We are going to get a little from Brazil and some from Canada but besides that where? With oil solidly over $100/barrel from 2011-2014 we didn't see much demand growth destruction. Demand grew 2,600,000 bpd in 2011, 800,000 bpd in 2012, 2,000,000 bpd in 2013. $75 oil isn't going to cause much demand growth destruction. Also....remember we aren't talking about demand destruction we are just talking about demand not growing by as much. In the last 30 years there has only been 3 years where demand as actually fallen. The first IRAQ invasion and the few years around the financial crisis in 2008-2009.
Probably easier to speculate on what would be unfair (unsustainable) price on a lower side and come to a minimum. My guesstimate in the mid-term (5 years) any price below 120 USD/bbl is unfair (doesn't mean it can't happen but there will be a reckoning hour for that later in the form even higher prices).
In short, I personally, would not and won't sell any oil instruments at prices for oil bellow 120 USD/bbl. Before oil has gotten to that level, which I believe it will, I will enjoy listening the romantic songs about the triumphs of Tesla and wind turbines.. :)