Oil Market Report June, 2017

We’ve hit the half-way point of the year, so not a bad time to take stock of the oil markets, see where we are and take a view on the rest of the year. In January, we predicted that prices would creep up slowly throughout the year – but this clearly hasn’t happened. Instead, we have seen flat / falling prices within the $45 – $50 per barrel range.

Not for the first time, the world seems to have under-estimated US shale oil. Most observers forecasted that shale would return to the market once prices hit the $60 mark. But in fact, the shalers have re-entered the market at great speed and in the kind of gung-ho manner that many predicted would characterise 2018. No doubt egged on by bullish price predictions, but also aided by the loosening of credit restraints (from lenders) and the pro-oil Trump effect, production is now in full swing. Every single week of 2017 has seen an increase in the number of operating US oil rigs, so that as of today, the total number is 750 – a 17% increase since the beginning of the year (January rig count was 630)…gung-ho indeed!

The resulting increase in US oil production has not only countered OPEC’s well publicised production cuts, but has actually outweighed them, creating the downward drive in prices that we have seen in the last few weeks. Not surprisingly, this has collectively left OPEC scratching their heads and wondering what they can now do to affect world oil prices. Even the covetous agreement of Russia to join in on production cuts has had little effect and the fact that OPEC’s May meeting (where extended cuts until March 2018 were announced) passed off with barely a whimper from the markets, may indicate that OPEC is now a busted flush…

Or is it that as ever with OPEC, the problem lies with executing their headline policies? By excluding Nigeria, Libya and Iran from the production cuts (for various different reasons), OPEC’s production “on the ground” has not actually fallen. And depending on the (deliberate in)accuracy of data coming out of Iran, it may have actually risen! So however disciplined the Saudis and Russians have been in holding back oil from the market, the world’s supply glut has continued and we are almost back to square one, with the shalers and OPEC facing off in a death spiral to the bottom.

What if anything will stop the downward cycle? Well this report always feels the need to remind readers that demand for oil continues to increase (already up by 0.75m barrels per day this year) and there is almost universal consensus that oil consumption growth will continue to a peak of around 100m bpd (currently at 91m bpd) by around 2025. However, the promise of a few more years of consumption growth will offer scant relief to the conventional oil producers, particularly when the shale oil industry seems to have the potential to destroy market value on a biennial basis. And from an investment perspective, 5-10 years of “security” is nothing like enough to justify the millions and sometimes billions of $ required to fund long-term conventional exploration plays. On top of that, factor in the growing popularity of gas, the tightening of global environmental regulation and the onset of electric cars and you have the ingredients for a potential flight from large-scale investment in oil.

Of course, some investors and oil companies will take the gamble. They will bank on the fact that if and when shale fails – or indeed oil demand continues to grow beyond 2025 – then those conventional oil wells left in the game will reap the rewards of higher prices. But the very nature of 21st century capital is that it looks for easy wins and at this juncture, there seem to be a number of easier wins available than investing in oil. When the Saudis announced that they intended to make an Initial Public Offering (IPO) for Saudi Aramco (the state oil company), initial market predictions were towards a valuation of an incredible $2tn (2.5 times the size of Apple Inc.). But as the months have passed, a far more sober evaluation has taken place and a value of circa $500bn is now expected. That’s still massive and let’s face it, the oil industry is not going to disappear overnight, but such a large downward re-evaluation must tell us something about the future of conventional oil.

If we come back to the short-term though and look at the rest of the year, our prediction of $65 per barrel now looks unlikely. But then again, 25 years in the oil industry teaches you that the expected rarely happens and never in the expected manner! A change in economic policy from either China or India, to artificially inject growth into their economies, could generate a significant increase in demand. Don’t forget President Trump either. In between sacking all his advisers and sending the Tw*ttersphere into meltdown, the newly elected President is still promising to re-introduce sanctions on Iran. And finally let’s not forget the spat between Qatar and the rest of the Middle East. If that turns properly nasty, the (upward) impact on oil prices could be huge…