Oil sector braces for volatility in 2019

11 December 2018
Uncertainty looms in the oil market with a new agreement to reduce output in the face of unstable prices and increased production from non-Opec countries

The crude oil market entered a tailspin with Brent crude prices tumbling 30 per cent from a high of $86 a barrel in early October in reaction to record production from the US, Saudi Arabia and Russia, and worries over economic growth. In the two weeks from 12 November, the price of Brent shed $10, dipping below $60 a barrel amid trading on 25 November before rebounding to $62 in early December.

US President Donald Trump added further downward pressure with his tweets urging Opec to drive prices even lower. “Oil prices getting lower. Great!” he tweeted on 21 November. “Like a big tax cut for America and the world. Enjoy! $54, was just $82. Thank you to Saudi Arabia, but let’s go lower!”

Tough decisions

On 7 December, members of Opec reached a deal with 11 other producers, led by Russia, to collectively reduce oil production by 1.2 million barrels a day (b/d) from 1 January in a bid to boost crude prices. The agreement came at Opec’s scheduled meeting at its headquarters in Vienna, following intense bargaining and negotiations guided by geopolitical and commercial considerations.

Mandated to be in force throughout the first half of 2019, the deal will see the 15-member Opec group bring down its output by 800,000 b/d, while the group of 11 other oil producers will cut output by 400,000 b/d.

The production cuts are intended to help prices settle at the $70 mark previously seen in 2018.

In the face of tepid demand, Saudi Arabia had been pushing for cuts of more than 1 million b/d to rebalance the market.

But it is unclear whether the cuts will be seen as a public affront to the US president, who has provided diplomatic cover since the unlawful killing of Saudi journalist Jamal Khashoggi. It is a tough balancing act for the kingdom to manage.

“Being hit in the pocket or being hit by Trump is the tough choice Opec will be facing when it meets,” noted Ole Hansen, head of commodity strategy at Saxo Bank, in a research note before the Vienna meeting.

Unpredictable market

The latest drop highlights the volatility of the market. Prices spiked to four-year highs in October ahead of the reimposition of US sanctions on Iran, Opec’s third-largest producer, which took effect from 4 November. But the impact of the sanctions has been much lower than expected, with Washington issuing a number of temporary sanctions waivers to Iran’s key customers. US officials had previously been emphatic that the target was to bring Iran’s oil sales down to zero.

Elsewhere, Libya has continued to pump more oil than expected and Venezuela’s oil industry has not collapsed as many had feared. The US itself has been the biggest contributor to the supply glut, hitting a record production level in August.

On 22 November, JP Morgan cut its outlook for oil prices in 2019, forecasting Brent at an average of $73 a barrel, down from $83.50 a barrel previously. The revision was in part due to the expected ramp up of US oil supplies in the second half of next year. The same day, S&P Platts Global’s results from a survey of 11 top oil forecasters pointed to a price of $75.5 a barrel, down from forecasts of $78.51 a barrel in early October.

Repeating history

There is a certain sense of deja vu in the market. After the price collapse witnessed in the middle of 2014, it took a year-and-a-half before Opec and non-Opec producers finally reached an agreement in December 2016 to cut 1.8 million b/d. In the build-up to the cuts, many of the producers had ramped up their output, so the cuts were from a higher baseline. This meant it took longer than expected for the cuts to have the desired effect of bringing inventories back down from more than 3 billion barrels.

Now, the Paris-based International Energy Agency (IEA) estimates that oil inventories held by OECD countries are on the rise again, hitting 2.875 billion barrels in September.

The IEA forecasts demand growing by 1.3 million b/d in 2018, down slightly from 1.5 million b/d expected earlier this year, and 1.4 million b/d in 2019. But its forecasts also point to a well-supplied market in 2019 with surging non-Opec output.

Both the IEA and Opec have raised their forecast for non-Opec oil production, seeing as much as 2.23 million b/d of new oil. Demand for Opec’s barrels at the same time could fall by 620,000 b/d to 31.3 million b/d in 2019.

Saudi Arabia’s Oil Minister Khalid al-Falih said earlier in November that the kingdom would begin cutting 500,000 b/d from its crude exports in December. However, November saw the kingdom push production to 11.1-11.3 million b/d, and raise exports to two-year highs, even as Al-Falih was calling for supply cuts, according to analysts citing vessel-tracking software.

Persisting volatility

“Opec has indicated its determination not to let the market slip back into oversupply in 2019, and we think it has given a clear indication of its intention to defend prices in the $70s,” HSBC said in a research note released on 15 November.

Al-Falih, who is Opec’s most important minister, has talked of the producers’ group as taking a role akin to a central bank. But the group cannot respond to changes in the new oil market quickly, and has found itself chasing market sentiment to stabilise oil prices.

The rapid price gains and sudden losses have highlighted just how quickly market sentiment can change, and this volatility could well continue through to 2019.

There are still many factors that could change the current situation. Libya has, against the odds, held its output relatively stable at more than 1.2 million b/d for several months. But without a lasting political settlement, its output will remain on a knife-edge. There are also question marks on whether the US will renew the waivers given to Iranian oil buyers when they expire in May 2019.

Longer-term lower prices in this sector could very well impact global investment in upstream exploration and production, which is only just starting to recover from the last round of cut backs.

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