Slump in conventional Oil Project Investment to Generate Deeper Trend

by shariff mohammed | Mar 02, 2017

Despite some uncertainties stemming from a Trump presidency, we project annual oil demand will continue to grow at around 1.2mb/d. OPEC cuts in 2017 should lead to a supply shortfall and allow for a substantial draw down of reserves, despite a small US shale oil led revival in non-OPEC supply.

Concerned over the slow re-balancing in the market and resultant record high stocks and weak prices, OPEC overcame political difficulties to agree a significant output cut at its November 30 meeting. Production is to be cut by 1.2mb/d to 32.5mb/d starting in January for an initial 6 month period, with a further 0.6mb/d in cuts to come from non-OPEC producers, principally Russia.

The market continue to think that the unprecedented decline in conventional oil project investment over the last three years will begin to have an impact on market balances by 2018 that will not be completely offset by US shale oil. Consequently we project that prices will be pushing $65/b in 2018. The IEA estimates that global upstream capital investment fell 25 percent in 2015, and will be down a similar amount in 2016. It is true that costs have also declined sharply, but substantial investments are needed just to replace lost output from depletion rates at existing fields which are running at 9 percent a year.

US rig counts bottomed out in May, and are expected to continue rising through 2017-18 driven by shale oil. Estimated break-even prices for shale oil producers have fallen remarkably in the face of cost declines and productivity gains. They are not universally low across all basins, but prices in the $55-65/b range will prompt a steady recovery in drilling. This will drive a recovery in total US output, following an estimated 0.5mb/d average decline this year.

Key Developments 2016

Oil markets have had a challenging year, with prices slumping to under $30/b in January, extending the sharp decline from their $114/b levels in mid-2014. However, after the false dawn in early 2015, prices finally found a floor, and since February they have been on an upward, albeit uneven, trend. During the year prices have fluctuated widely as markets looked for a clear sign, or otherwise, that fundamental balances were tightening as higher cost supply was pushed out. In this respect, similar to in 2015, expectations of a rebalancing continued to be pushed into the future as, among other things; oil projects conceived during the $100/b period continued to come on stream; OPEC supply continued to surge, and global stock levels remained at record levels. In this uncertain environment, weekly movements in stocks and US rig counts, as well as unexpected supply disruptions, and shifting OPEC strategy, have all driven the market, with price moves accentuated by shifts in large financial investor positions and the value of the US dollar.

In the end, the continued weak and slow rebalancing in the market pushed OPEC into its first production cut agreement in eight years in November, reversing the “market share” strategy initiated two years ago in November 2014. This has pushed Brent back up to around $55/b, and means that the average price for the year should now come in at over $47/b, still 18 percent down on the $58/b 2015 average, and less than half the $100/b plus prevailing during 2011-14. Some of the key developments leading up to the OPEC agreement include:


  • Post-sanctions Iranian supply boost: Against some expectations, Iran has been able to rapidly boost supply this year following the lifting of sanctions in December 2015. Production has risen by nearly 1m/d to around 3.7mb/d, bringing exports back to their pre-sanctions level of 2.2mb/d.
  • Failed OPEC talks in April, launch of Saudi Vision 2030: With concerns mounting that the rebalancing of the market was taking too long, OPEC was on the verge of agreeing an output freeze in April, with possible Russian cooperation. In the event Saudi Arabia pulled out, in part due to Iran’s refusal to contemplate production curbs until it had restored output to pre-sanctions levels, but also reflecting the adoption of a bold new transformation plan for the kingdom away from oil dependence outlined in its Vision 2030, and including a part sale of the state oil company Aramco. At the same time a new expanded Energy, Industry and Natural Resources minister was appointed who suggested that markets needed to rebalance through low prices, and that Saudi Arabia had the resources to wait.
  • Soaring OPEC and Russian supply: With the Saudi driven “market share” strategy still in place, OPEC production has soared during the year. As well as resurgent Iranian production, Saudi output has risen to record highs and Iraqi supply continued to grow. This has offset disruptions in other members such as Nigeria, pushing OPEC supply to a record 34mb/d. At the same time Russia has pushed production up to a record 11.2mb/d.
  • US output developments and supply disruptions: Through the first half of the year markets were heartened by a steady fall in US production and rig counts. At the same time, a spate of supply disruptions in a range of countries including, Nigeria, Canada, Sudan, Kuwait and Libya, helped offset returning Iranian supply. However, since June both US rig counts and output have started rising again, while earlier supply disruptions have generally eased.
  • Faltering stock draws: The rebalancing in the market and resultant draw on record stock levels has been slower than expected. Available data show that total OECD stocks have drawn down this year through August. But they remain exceptionally elevated; and the US reported record stock builds in October/November which unsettled the market.
Surprise US election victory: The impact of Donald Trump’s victory on oil markets is uncertain. On balance we think global growth will pick up, but his presidency does present downside risks for emerging markets, the main driver of oil demand growth. However, perhaps the key issue is Trump’s vow to dismantle the nuclear deal with Iran. It is not clear how or whether he really wants to pursue this as the deal is incorporated into international law by the UN Security Council. But there is a non-negligible chance that US sanctions could be re-imposed, curbing Iranian supply. The US House of Representative have already passed a 10 year extension of the Iran Sanctions Act for non-nuclear related activities which expires at the end of the year. The bill is now headed for the Senate and the president’s office. If approved it would facilitate rapid activation of sanctions currently not in force under the nuclear agreement

OPEC and non-OPEC producers agree to 1.8mb/d in cuts
Market Outlook
Global oil demand growth expected to soften
Global Growth Momentum should be maintained
OPEC supply restraint will be key
US shale oil set to rebound
A long lists of risks


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