As we roll into 2018, analysts and investors are more optimistic that the oil market will further tighten next year and support higher oil prices, but rising U.S. shale production will likely cap any significant price gains.
On the demand side, expectations are that global economic growth will support solid oil demand growth. On the supply side, Venezuela’s dire situation, possible new sanctions on Iran, and increased tension in the Middle East mostly with the Saudi-Iran issues and the Iraq-Kurdistan standoff may take more barrels off the market than OPEC and friends plan, and send geopolitical jitters through the oil market.
However, according to energy policy expert Michael Lynch, there remain three potential events in the markets that could send oil prices tumbling. These include a large correction in the U.S. stock market that could spread to a sell-off in commodities; one of the OPEC members or Russia breaking away from the unusually strong compliance to the cuts we have seen so far; and U.S. oil production rising so much as to make OPEC see it as a threat to its long-term oil market share.
In markets, there are already some signs that we may be seeing some bubbles, Bitcoin being the most likely candidate, according to Lynch. In addition, the price to earnings ratio of the S&P 500 index is now over 25, well above the mean historical average of just over 15.
Last week, Fed Chair Janet Yellen said, referring to the high valuation in some asset classes, “the fact that those valuations are high doesn’t mean that they are necessarily overvalued.” According to VTB Capital’s Global Macro Strategist Neil MacKinnon, the ultra-low volatility in U.S. equities this year is “very vulnerable” to shocks, and current stability could actually bring future instability. Related: U.S. Asks China To Implement New Oil Sanctions On North Korea
According to Lynch, if the U.S. market moves into bear territory next year with a big correction, it could spread the financial contagion to commodities such as oil.
Another potential threat to oil prices is that of an OPEC/non-OPEC pact participant beginning cheating outright—Iraq and Russia, for example—which could lead to the Saudis deciding to let the price of oil drop, Lynch argues.
Yet the Saudis have little choice but to support oil prices because of their heavily oil-reliant economy and the planned IPO of Saudi Aramco, Amy Myers Jaffe at the Council on Foreign Relations wrote in the Houston Chronicle last week. According to Myers Jaffe, if Russia makes a U-turn and boosts its oil production, the ultimate battle for market share will be between the U.S. and Russia, despite the fact that Saudi Arabia continues to hold influence in the oil policy of OPEC and its partners.
“For now, Russia seems content to collaborate with Saudi Arabia on oil market stability, which ironically also suits the current U.S. administration, whose America-first jobs message is tied heavily to the economic engine of the shale revolution,” Myers Jaffe said.
The shale revolution and the rise of U.S. oil production is the third possible factor that could lead to an oil price collapse, Lynch argues. If OPEC sees that it needs to defend market share in the long run, chances grow that the cartel may decide to let oil prices drop, Lynch says. Related: Is Premium Gasoline A Waste Of Money?
OPEC is now outright acknowledging that U.S. shale outperformed initial expectations, and last week the cartel revised up its projections for non-OPEC supply growth for this year and next.
The International Energy Agency (IEA), for its part, said that while OPEC producers had decided to roll over the production cuts to the end of 2018, non-OPEC supply would increase more than previously expected, and total supply growth could exceed demand growth next year.
The EIA forecasts in its latest Short-Term Energy Outlook (STEO) that total U.S. crude oil production will average 9.2 million bpd this year and 10.0 million bpd in 2018, which would mark the highest annual average production, surpassing the previous record of 9.6 million bpd from 1970.
OPEC is well aware of the second U.S. shale resurgence, and it looks like it’s currently sacrificing short-term market share in the name of higher oil prices—or “oil price stability”, as it loves to call it. As for letting the price of oil slide, OPEC members’ budgets may currently need higher oil prices even more than some U.S. shale drillers do.
While many analysts and OPEC expect the oil market to finally rebalance at some point in late 2018, a sharp correction in the financial markets, a dip in OPEC/non-OPEC compliance, and the market share wars could result in lower oil prices, or in the extreme case—in an oil price crash.
By Tsvetana Paraskova for Oilprice.com
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Circumstantial evidence suggests that one has to take announcements by the EIA of increases in US shale oil production and rising US oil stocks with a big pinch of salt.
Though Russia can live with an oil price of $40/barrel or less, it is not going to leave the OPEC/non-OPEC agreement on production cuts before there is a re-balancing in the global oil market. This is now projected to occur some time in mid-2018 if not much earlier .
And despite rising production and growing need for more revenue, Iraq is not going to rock the boat by withdrawing from the production cuts agreement.
Saudi Arabia will continue to support higher oil prices because it needs an oil price of $70/barrel or higher for a successful IPO of Saudi Aramco and replenishing its depleted financial resources.
Add to this positive global oil market fundamentals and you get an oil price rising to $70 or more in 2018.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London
1. The market will correct - to what degree is the correction and will it involve a rotation into the energy sector? A large macro correction (just don't see it with the tax cut and growth on the horizon) would def. spill over to the oil markets. A correction based on valuation (tech etc) - could instead be a catalyst to rotate into the energy sector which is still undervalued. (see mid-stream)
2. Compliance - as a whole compliance has been over 100% led by SA. Does a different mindset - cheating - really make sense? Why change course when stocks are falling and your getting a progressively better price? Actually, I suspect there will be mild cheating in the early spring - not because of a different mindset but in fact to keep prices from rising too fast.
3. Marketshare - world-wide demand will grow with a robust global economy. Rising water raises all ships (plus the decrease in Ven., Mexico and Norway) will allow OPEC to maintain its marketshare. Still, even a small decrease (mainly US) makes sense if they can sell roughly the same amount of output at prices 20, 30 and 50% more than 2014-2016.
In my humble view, it is higher oil prices that will bring that next recession...not the other way around. Spiking oil and interest rates by late-2019/early 2020 will put the brakes on a feverish growth rate - 3.5% of 2018 trending to 4.5% into 2019. With that growth - oil we be flirting with $100/barrel...
Peak-oil demand as a lot closer than generally expected.
With about 80% of oil being used for transportation, the following needs to be noted:
a. Electrification of passenger cars is accelerating. While Tesla fetches the big headlines, virtually every major car manufacturer is now selling all electric cars, with plans for an avalanche of new models to be introduced within months. GM has no fewer than three all electric SUV's in works. BMW sold over 100K electric cars this year - did anyone even know that they have an electric car . . .?
b. While Tesla again garners the headlines about producing electric tractor-trailer, all other truck manufacturers have been and plan introducing hybrid trucks soon, and the only difference is that they will actually deliver those trucks . . .
c. Natural gas is increasingly being used in public transportation and even railroads are experimenting with the conversion.
Now, I am not suggesting that all those elements will have an immediate and direct significant impact on the demand, however the major producers whose existence depends upon selling the oil are quickly realizing that their assets in the ground will soon (decade(s)) rapidly decline in value, so they cannot afford to loose market share and will have to pump more to protect their future.
The NOPEC production side:
The American shale on the other hand is a pure capitalist play - get it out as fast as you can so long as you can sell it at a profit.
And, while American shale gets all the front page billing, Argentina, Russia and China have even greater shale deposits, albeit without the infrastructure in place for major extraction. But having seen what China can do in building infrastructure, that factlet should be discounted pretty quickly.
And finally, Russians have stayed with the OPEC limits for now, as they are taking market share from the Saudis. However, Russia is not USSR - that is to say that the oil is produced by a large number of private and semiprivate companies, many of which have joint venture obligations, and therefore the Russians have a way of selling oil outside of the OPEC agreement, and considering the fact that investments in new production was not abated, it stands to reason that that oil will find its way to the world market - one way or another.
The biggest potential problem is geopolitical - Russia may exacerbate the conflict between Iran and the Arabs and then we would see $100 oil . . . . .
All of their balance sheets are in RED. DARK RED.