Oil market getting used to looking up, not down

 

Saudi Arabia’s new energy minister Khalid Al Falih is in a quandary. On the one hand, still bloated global oil inventories that drove this year’s prices to lows last seen in 2003 concern him. At the same time, the slashing of hundreds and billions of dollars of investment in future projects by the world’s biggest energy companies might be storing up problems.

 

After dropping below $30 per barrel in January, the price of Brent crude has risen to more than $50, suggesting that not only has the market bottomed, but a sustained recovery is under way after a protracted fall that started almost two years ago. But at what price the market finds balance is flummoxing even one of the most influential figures in the oil industry.

“This is still a discovery process,” Mr Falih said at last week’s meeting of Opec ministers in Vienna. He hoped prices would “equalise somewhere moderate” to prompt enough investment and supply to meet demand, but not “too much investment to the point that we create an oversupply and a glut again”.

 

Prices at more than double today’s levels triggered an investment binge in recent years, supercharging the development of technologies that unlocked the

 

For Mr Falih, $50 a barrel is unlikely to get the industry lifting capex. “I think the level is going to be higher than [that],” he said. Investment in oil and gas fell by $160bn in 2015 and could drop by another $50bn this year, according to energy major BP.

“We have tested $100-$110 [a barrel] and found out it was bringing too much supply.” The ideal price, for Mr Falih, would be “somewhere in between”.

The conversation in the market is now focused on a rebalancing by the end of the year, as supplies of high-cost oil decline and rising consumption from motorists and other oil users helps take care of excess stocks.

“The market is changing its stance on the potential for a market rebalancing occurring sooner than previously expected,” says one Wall Street trader.

Saudi Arabia’s careful diplomacy last week, promising co-operation with other Opec members, created a united front anddamped fears the kingdom was preparing to ramp up production significantly in its battle for market share. Furthermore, remarks from Opec’s kingpin that the group should gently coax the market rebalancing were also seen as an effort to bolster prices.

“[Saudi Arabia’s] comments made clear it would not flood the market. Its behaviour has been very constructive towards prices,” says Gary Ross, executive chairman at New York-based consultancy Pira Energy.

Unplanned supply outages — from Canada to Nigeria and Libya — have also helped prices double from the January lows. Disruptions averaged around 3.7m barrels a day last month, according to the US Department of Energy. These have more than offset an acceleration in output from Iran and Iraq, analysts say. Although some outages are short term, as a result of maintenance of fields, fires or strikes, others are longer lasting.

“What’s happening in Nigeria is not accidental,” says Paul Horsnell, head of commodities research at Standard Chartered.

Niger Delta Avengers, a militant group, has damaged the energy installations of companies such as Royal Dutch Shell and Chevron, slashing the country’s output to its lowest level in more than two decades. Despite a push by politicians for dialogue, the militants say they are not open to negotiations.

“There is a change in dynamic, politically, that assumes continuing production losses in the Niger Delta,” says Mr Horsnell.

Oil bulls have also drawn support from declines in output from US shale formations and strong growth in fuel consumption. In the US, crude oil production has declined by more than 900,000 b/d since April 2015 to about 8.7m b/d last month, while petrol consumption was poised to break records this year.

Despite a mixed picture for the global economy, demand for oil has stayed robust and the International Energy Agency, the world’s leading energy body, could revise upwards its consumption estimates for 2016. A weaker dollar has also helped.

Although all eyes are on global stocks — which some analysts estimate are easing by more than 1m b/d on average, a rate that is likely to continue in the third and fourth quarter — a consensus about when the market will balance and at what price remains elusive.

If global oil inventories continue to rise through to next year, any price rise could have limitations. Onshore stockpiles in industrialised nations have grown from 4.4bn barrels in March 2015 to more than 4.6bn barrels in the same month this year, according to the IEA.

“The scale of the stock overhang is big,” says Spencer Dale, chief economist at BP, after the release of the company’s closely watched oil data review on Wednesday. “We need to take that into account when thinking about price trends.”

A restoration in supply from Canada and elsewhere, as well as any resurgence from US shale producers amid higher prices, also needs to be considered. Some analysts say consistently higher prices and long lead times are required for shale production to resume. But others insist some fields are already primed and the number of US rigs drilling for oil is on the rise.

Even so, as the oil price hovers around $52 a barrel, analysts believe the odds still favour a further move higher in prices.

“There is plenty of oil to keep ourselves going for the moment, but at some point you’re going to have to ask how we encourage supply back and what price does this need,” says Mr Horsnell.

“As we whittle down this inventory, right now we are witnessing a big sea change in psychology in the oil market.”