Recognizing that something had to be done to halt the latest crash in oil prices, Saudi Arabia’s energy minister went public with his support not only for an extension of the OPEC cuts for another six months, but he also dangled the possibility of an extension into next year.
“Based on consultations that I've had with participating members, I am confident the agreement will be extended into the second half of the year and possibly beyond,” Khalid al-Falih said during an industry event in Kuala Lumpur, according to Reuters. At the same time he waived away the signs that the market is still woefully oversupplied, acknowledging the larger-than-expected rebound in U.S. shale, but still noting that the fundamentals are improving. "I believe the worst is now behind us with multiple leading indicators showing that supply-demand balances are in deficit and the market is moving towards rebalancing," he said.
Up until now the decision was whether or not to extend for six months. Now, with a six-month extension looking assured, there are questions about whether even that will be enough. The oil markets no longer appear to be impressed by a six-month extension, judging by the increasingly languid price responses that have come after OPEC comments in recent weeks. OPEC was very successful at talking up oil prices last year, but the rhetorical power of al-Falih is on the wane.
With the six-month extension now baked in, OPEC is growing concerned that inventories might still be elevated by the end of the year. As a result, OPEC is starting to look at a nine-month extension, according to Reuters. “To increase production in those months may have a negative impact (on prices). So we may ask for an extension until the end of Q1 of 2018,” an OPEC source told Reuters. Related: Is The Market Ignoring OPEC?
However, the Saudi energy minister also cautioned that oil watchers are being myopic, becoming overly-focused on the near-term while neglecting the longer-term fundamentals. He argues that demand will continue to rise and the severe cutbacks in exploration over the last several years are sowing the seeds of a shortage by the end of the decade. The comments echo recent warnings from the IEA about the pending supply shortage because of a dearth of discoveries since 2015.
“Conservative estimates predict that we will need to offset 20 million barrels per day in combined demand growth and natural decline over the next five years,” Falih said over the weekend. “That is why I fear...we are heading into a future of supply-demand imbalances.”
Many of the top energy analysts tend to agree with al-Falih’s near-term assessment – that the recent selloff might have gone a little too far due to some technical trading particulars rather than the reemergence of a supply glut. The oil market, however ploddingly, continues to adjust towards some sort of balance.
But even as he agrees with al-Falih’s characterization of what’s taking place right now, Ed Morse of Citi disagrees very much with the minister’s medium-term assessment. That is, Morse argues there will not be a supply shortage at the end of the decade. Related: Saudis Set To Cut June Crude Oil Exports To Asian Markets
In an FT column, Morse lays out his case, arguing that U.S. shale will add new sources of supply; other sources of supply will come from Russia, OPEC and other non-OPEC countries; demand is softening because of improved efficiency; and even oil sands and deepwater drilling have become cheaper by some 20 to 30 percent. Morse also said that natural depletion is not as much of a concern as many think, arguing that only 40 million barrels per day of non-OPEC production – rather than all of the world’s 100 mb/d – is of real concern for natural decline. That means that “only some 10 mb/d of oil requires replacement over five years and technology and capital efficiency put that easily within reach,” Morse wrote in the FT.
Ultimately, Citi does not foresee the price spike towards the end of the decade and into the 2020s that the IEA has warned about. The industry has structurally reduced costs and can grow production even with oil trading at today’s prices. That could ultimately mean that prices never go back to $100 per barrel.
Volatility could pick up, especially in the short run, but Citi is projecting oil prices to trade within the $40 to $65 per barrel range over the next five years.
By Nick Cunningham of Oilprice.com
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