The Fuse

18 Months In, Saudi Arabia Says Oil Market No Longer Oversupplied

by Leslie Hayward and Matt Piotrowski | June 02, 2016

Khalid al-Falih, Saudi Arabia’s newly appointed Energy Minister, in his first statements to press for the week, stated that the oil market is no longer oversupplied, although the inventory overhang remains.

Falih also highlighted Saudi Arabia’s role in the market. Taking a similar line to his predecessor, former Saudi Oil Minister Ali al-Naimi, Falih spoke towards Saudi’s role as a reliable supplier that will continue to meet global demand, which remains open to cooperation with both OPEC and non-OPEC producers. He also addressed the global underinvestment risk, and said that OPEC’s Gulf member states are concerned about a potential price spike.

“The market is doing quite well by itself and we will be very gentle in our approach so we do not shock the market. Our concern is for the long-term stability of the market,” he said. “We don’t want oil shocks in any way. In the long term, we want to encourage investment.”

“Saudi oil policy officials are more worried about underinvestment in supply sowing the seeds for a wild price spike into the triple-digit range down the road than oil prices in the near term,” Bob McNally, President of the Rapidan Group, told The Fuse. “Boom and bust oil price cycles are no fun for Saudi Arabia, other producers, or for that matter anyone else except talented traders and storage owners.”

“Boom and bust oil price cycles are no fun for Saudi Arabia, other producers, or for that matter anyone else except talented traders and storage owners.”

Underinvestment concerns were reiterated in the opening address. “Global exploration and production spending fell by around 20 per cent last year, and a further 15 per cent drop is anticipated this year. This is a major concern for an industry that generally sees investments increasing year on year to sustain production,” said Dr. Mohammed Bin Saleh Al-Sada, Qatar’s Minister of Energy and Industry and President of the OPEC Conference.

Market already rebalanced?

Falih’s comments that the market is rebalanced aligned with comments from ministers of other Gulf states, but hasn’t been reflected in official estimates. For instance, the U.S. Energy Information Administration sees supply some 1.04 mbd ahead of demand for the second quarter, and a surplus persisting for the rest of the year. The International Energy Agency (IEA) has a similar estimate for the second quarter, putting the surplus above 1 mbd. The agency sees balances at .2 mbd by the end of the year, much tighter than the EIA, but still a surplus nonetheless.

The global market has no doubt tightened from outages, particularly those in Nigeria, but it may be too soon to say that a new equilibrium has occurred, in large part because OPEC production has been so high on the back of Iran ramping up output. The cartel is now pumping around 32.5 mbd, up about .25 mbd from the end of last year. It’s also important to note that many outages, while taking supply offline in the short run, don’t reflect a rebalancing of fundamentals in the long run. For instance, the Kuwait strike and Canadian wildfires this spring cut global supplies but they were temporary in nature. The Nigerian oil minister says he expects full production at Forcados by August, which suggests that the country’s output should rebound in time.

“The spate of large oil supply disruptions including Nigeria, Iraq, and Canada has accelerated the return to supply and demand balance most analysts had been expecting in the second half of the year,” said McNally. “Inventories are still high, but production is coming faster into line with demand.”

Fractures between Saudi Arabia and Iran persist

At today’s meeting, Zangeneh spoke about Iran’s success in returning to the market and plans to continue increasing production to 4.8 million barrels per day (mbd) in five years.

Spectators were looking for signs of fence mending between Saudi Arabia and Iran this week—a source of internal strife within OPEC that has undermined the unity of the cartel. Following comments from senior Gulf sources in Reuters and Bloomberg, and a meeting between the OPEC Gulf States of Kuwait, Qatar, UAE, and Saudi Arabia last night, renewed rumors circulated that OPEC would seek to reinstate a production target, and that Saudi Arabia remained open to pursuing collaborative action. These rumors were contradicted by comments made by Iranian Oil Minister Bijan Zangeneh on his late arrival in Vienna, who stated he had “no expectations” for the meeting, and that the only purpose was to elect a new Secretary General.

At today’s meeting, Zangeneh spoke about Iran’s success in returning to the market and plans to continue increasing production to 4.8 million barrels per day (mbd) in five years.

“They didn’t believe that we could return to our level of production so quickly, but now everyone sees we are returning more quickly than expected,” he told reporters. “Thankfully, the way we have returned to the market has not had negative effects on [prices]. In the longer term, in our five-year development plan, we target 4.6 mbd output, and with the addition of condensate, that will be 5.6 mbd.”

Zangeneh also argued for a return to the individual country quota system. When asked about Iran’s quota, he argued for a percentage system based on previous allocations. “It’s very clear, we had the share before the sanctions. 14.5 percent of the total output was the share of Iran in OPEC,” he said. Iran’s refusal to constrain output has been seen as a primary driver of the collapse of the talks to freeze production earlier this year between OPEC members, Russia, and other non-OPEC oil producing countries.

Libya’s production to rise?

“ISIS has now been moved out of the oil crescent, and the political side is being resolved. Technically, the oil fields and terminals are in pretty good shape.”

There is also upside risk to production in Libya, which is now producing just .4 mbd. The country’s delegation told The Fuse that it is confident it can ramp back up to full production of 1.6 mbd, and it could occur as soon as this year. They are upbeat for a political resolution in the country and say the oil fields and terminals do not have permanent damage. Such an uptick from Libya would further delay the global oil market rebalancing, similar to what has occurred with Iran ramping up output.

“It is still low but in the near future it will gradually come back to normal production,” said the Libyan delegation. “ISIS has now been moved out of the oil crescent, and the political side is being resolved. Technically, the oil fields and terminals are in pretty good shape.”

Venezuela ‘hoping’ for $60-$70 oil

One other major flashpoint is Venezuela, which is in severe economic turmoil amid almost two years of low oil prices. When asked by reporters about the state of the country, Venezuela’s oil minister Eulogio del Pino said that all producer nations in fact are undergoing stress, and not to read into Venezuela’s stress specifically. “All the producers in OPEC, in this situation, that we have had such a long period of low prices, are having economic problems,” he said.

He said that he “hopes” for oil prices to hit $60-$70 by the end of the year, but he didn’t give any reasons why that level would be reached. “We are fighting to have an equilibrium price that has a rate of return that is fair for everybody,” del Pino said.

He confirmed that Venezuela, now producing 2.8 mbd according to del Pino, is indeed importing US light crude but said not a big deal should be made of this current trend. “We are buying crude oil from different producers,” he said. “We have a refining system in the U.S., Citgo, and Citgo is importing crude. Why a big deal?”

He added that the country is targeting 3 mbd by next year with a rise in oil prices. The figures del Pino gave are questionable—both the EIA and IEA peg the country’s production at around 2.3 million-2.4 million bd.

In del Pino’s view, going forward, OPEC countries should have “production range” targets that each adhere to. This way, the cartel can have discipline, but each member can have flexibility by producing within their respective ranges.

In his view, going forward, OPEC countries should have “production range” targets that each adhere to. This way, the cartel can have discipline, but each member can have flexibility by producing within their respective ranges. Moreover, del Pino believes this type of system could bring in non-OPEC countries, such as those who participated in the Doha freeze talks and are in favor of coordination to manage supply levels.

Throttling non-OPEC supply while boosting demand

Beleaguered producers like Venezuela and Nigeria, although they continue to suffer under low oil prices, have been less vocal in their opposition to Saudi Arabia’s strategy some 18 months following the decision that rattled markets and sent prices plunging. According to an analysis released this week by Securing America’s Future Energy (SAFE), Saudi Arabia’s strategy has been a clear success for OPEC, with severe long-term ramifications for non-OPEC supply and global demand.

“The OPEC strategy aimed to use an extended period of extremely low oil prices to structurally rebalance the oil market on terms that will benefit OPEC and other large global oil exporters over the coming decade,” the report states. “Their goal is to return the market to a condition of relative short-term scarcity in which sellers have substantial leverage over buyers, thereby maximizing OPEC’s ability to influence prices and extract large resource rents from oil consumers across the globe.”

“The OPEC strategy aimed to use an extended period of extremely low oil prices to structurally rebalance the oil market on terms that will benefit OPEC and other large global oil exporters over the coming decade,”

SAFE’s report argues that Saudi Arabia’s strategy has four main components: (1) recapture short-term market share from U.S. shale and other responsive sources of global supply; (2) undermine investment in capital-intensive, long-term, non-OPEC oil supplies such as global deepwater resources and Canadian oil sands; (3) stimulate short-term oil demand through low prices; and (4) undercut global policy to reduce oil consumption, including fuel economy standards, as well as competition to oil, such as electricity and natural gas. The report argues, “There is compelling evidence that all four components are already succeeding,” and breaks down the following impacts on U.S. supply and demand.

U.S. Supply Impact: Since peaking in October 2014 at more than 1,600, the number of active oil drilling rigs operating in the United States has plummeted 78 percent to about 340 today. Low oil prices have triggered a wave of more than 100,000 layoffs and dozens of bankruptcies in the U.S. oil industry, increasing the country’s exposure to the volatile global oil market. The price collapse has seen private investment in new production capacity suffer, with over $380 billion in global deferred capital expenditures (as of January 2016), equivalent to 27 billion barrels of oil.

U.S. Demand Impact: Because of suppressed gasoline prices, vehicle miles traveled (VMT) in the United States will exceed 3.2 trillion miles in 2016, an all-time record. Sales of SUVs in the United States have also skyrocketed, increasing 13 percent year-over-year in 2015. Sales of smaller, more efficient cars suffered, and in 2015 U.S. fleet-wide fuel economy posted its first decline in years. Lower oil prices have also prompted automakers to pressure regulators to loosen federal fuel economy standards, potentially threatening the mid-term review of the 2009 CAFE standards and creating a significant setback for fuel efficiency and advanced fuel vehicles.

The price of oil tumbled from June 2014 highs of over $110 per barrel to the mid $20s by January 2016. Oil price volatility increased dramatically, hitting levels in early 2016 last seen in the wake of the 2008-9 financial crisis. Moreover, Saudi Arabia flooded the market with its spare capacity reserves as prices dropped—increasing output from 9.6 million barrels per day (mbd) in November 2014 to 10.2 mbd by March 2015. Saudi Arabia is expected to increase production this summer to meet domestic electricity demand, although the likelihood of a production surge is unclear. According to Falih, “We are going to be responsible, but also we’re going to be responsive. If there is for any reason a shortage in the market and we’re called upon to meet demand, we will do what we have to do. I don’t call that flooding. We’re just going to supply the market.”

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