Oil Prices: Quo Vadis?
Oil, the primary energy resource of the transportation sector is still the leading resource in the energy mix with a 34.2% share in total world energy consumption. It is also the main feedstock for the production of thousands of industrial goods and the petrochemical sector at large. The world consumes approximately 99.6 million barrels of crude oil daily, 33 million barrels of which is produced by the OPEC member countries.
Expected Rise in Demand
International Energy Agency (IEA) has forecasted a 1.3 million barrels/day increase in oil production in 2018. The Agency notes in their December 13, 2018 report that, although the demand from non-OPEC countries have contracted due to high oil prices, demand from OPEC countries for the 4th quarter is expected to rise somewhat.
The IEA is projecting a 1.4 million barrels/day increase in world crude oil demand in 2019. The recent fall in oil prices has not contributed to demand so far, and this, according to IEA, is because of slower GDP growth and the devaluation in certain countries such as Venezuela.
When we compare the oil production in November of 2018 with that of 2019, we see a 101K barrels daily reduction due to drops in production in the North Sea, Canada and Russia. The descent is primarily marked by non-OPEC countries.
As for OPEC production, we see a 100K barrels per day increase in production in the same period, thanks to record outputs in Saudi Arabia and the UAE. The cartel’s production has shot up to 33.03 million barrels/day. This increase more than covers the loss of output from Iran which is under another USA embargo.
OPEC has also decided to curb its output by 800K barrels/day starting in January of 2019, to help pump up the declining prices. OECD’s oil stocks have been on a rally for the last four months and increased by 5.7 million barrels to reach 2.87 billion barrels in October 2018. The stocks in March were already at a 5-year high, which is one of the main reasons for the low prices. Oil prices have gone by 30% since then, but they seem to have stabilized with Brent crude trading around $60/barrel and WTI at $52/barrel area. Low demand is affecting gasoline and NAFTA markets, while crude oil and transportation rates are at a multi-year high.
Where is the Price Heading?
Under the conditions I have outlined above, Qatar announced its departure from OPEC on December 3, 2018 to be in effect as of January 1, 2019. Petroleum ministers from both OPEC and non-OPEC countries convened in Vienna on December 7, 2018 which resulted in a decision to cut the OPEC production by 800K barrels/day, and non-OPEC production by 400K barrels/day, bringing the total cut in production in January 2019 to 1.2 million barrels per day.
There may be many reasons behind Qatar’s decision to withdraw from OPEC, but the fact that they will be able to sidestep the compulsory OPEC production cut is likely the primary one. Another reason may be Qatar’s desire to be freed of a cartel that is strong-held by Saudi Arabia -a country trying to get Qatar under an embargo. We can also deduce that the remaining OPEC countries will be affected less by the output decrease. In the end, Qatar will continue to produce 619K barrels of oil daily, and their decision to leave OPEC will not have any consequences on their production.
In order to comprehend the reasons behind the price drop, it is sufficient to look at the fall in world oil demand coupled with the production increases in the US (with the contribution of tight oil production), Saudi Arabia, Russia and Libya. These factors were thought to continue to have similar effect for 2019 provided there wouldn’t be any production cuts, and now that the new production numbers will come into effect in January of 2019, we might see the imbalance continue to creep for a few more weeks.
The impact of Iran’s output cut is not immediately apparent thanks to their various practices such as the cover-up practices they use on their oil tanker monitoring systems, oil transfers between ships in the open seas, etc. It also remains to be seen how compliant OPEC and non-OPEN countries will stay to the newly signed agreement.
Other parameters that will set the course of oil prices in the upcoming period will be the production strategies of the three largest oil producing countries (USA, Russia and Saudi Arabia), as well as geopolitical developments, reserve levels, seasonal changes. The budgets of oil exporting countries, with Russia and Saudi Arabia in particular, are highly dependent on their oil economies.
The USA, is on a playing field of its own, however. Currently, the USA is the world’s largest oil producing and consuming country. They prefer lower oil prices since their production (12 million barrels) is still less than their consumption (19 million barrels). Oil companies, on the other hand, are all for higher prices as long as they don’t affect the demand negatively. According to their Department of Energy, the US has become a net oil exporter in the week before November 2018, for the first time since 1991. But it is still known that, the US has been importing approximately 3.1 million barrels daily. This used to be as high as 11.1 million barrels prior to Shale Revolution. It can be said that thanks to the technological advances made by the US helping them supply more oil to the markets, the impact of the 1.2 million barrels/day reduction will likely be limited.
There are expectations for higher production from Brazil, Canada and Norway. These countries are likely to contribute to the increase in non-OPEC production.
IEA is bracing for a two-tier development in oil markets for the next 6 years. It is expecting to see the increasing demand up until 2020 to be met by record productions from non-OPEC countries. They also warn that, unless the necessary investments are made until 2023, spare production capacity will fall to 2.2% of total demand -the lowest it has been since 2007. This will potentially have a destabilizing effect on oil prices.
Although the production of “Shale” oil is starting to adapt to the market conditions, IEA is still expecting the world demand to be primarily satisfied by OPEC. Almost all of the spare production capacity of OPEC, which is 2 million barrels/day, is controlled by Saudi Arabia. It follows from here that, SA’s policies will be a main determinant for the stability of the oil market (Note: the IEA defines spare production capacity as the oil that can be pumped into the market within 30 days uninterrupted for at least 3 months without any additional investments)
The United States Department of Energy projects the price of Brent crude oil to average $61 in 2019, compared to $71 in 2018. The average price of oil in 2017 was $54.2/barrel, so we can see how oil importing countries such as Turkey are likely to suffer economically in the upcoming period. Oil prices are also a vital ingredient in the calculation of natural gas prices, so we can expect a higher natural gas bill, too. We also have the issues with weak Lira compared to the Dollar to think about, which all culminate to make us face the reality of being an energy-dependent country.
I wish everyone a happy new year that will hopefully bring in a cleaner, more independent, and renewable-heavy energy policy for the world countries.