 "Opec is determined to defend its market share: Vandana Hari")
Benchmark crude oil prices have seen a sharp fall through the past couple of months. What led to this?
Against a high of $115 a barrel in mid-June, the nearly 48 per cent drop in benchmark Brent crude oil prices can be attributed to a growing global supply-demand imbalance. The surging US oil production this year has been a major factor behind a supply glut and ballooning inventories in the Atlantic basin, while global demand has been easing.
Meanwhile, in addition to European demand slipping further into negative territory amid the region’s fresh economic troubles, oil consumption in China, the world’s second-largest consumer after the US and the biggest contributor to global demand growth in recent years, has slowed to a crawl.
Prices got a renewed downward push after the Organization of the Petroleum Exporting Countries (Opec), at its November 27 meeting, decided to stick to its 30 million barrels/day production target, even as consensus observations suggested a cut of 1.5-2 million barrels/day was needed to mop up excess supplies.
By when and at what levels do you see the prices bottoming out?
I think global oversupply and lacklustre demand conditions responsible for the fall in oil prices in recent months are expected to persist in 2015. With a production cut by Opec out of the picture for now and as long as there are no unforeseen major supply outages, one can expect prices to remain under downward pressure, reflecting an expected 1.5-2 million barrels/day of extra oil continuing to flood the markets. The situation could be further exacerbated in the second quarter, the traditional season of low demand, when refineries globally undergo annual maintenance, slashing demand for crude. Such expectations have led market observers to conclude prices might slide below current levels.
The eventual rebalancing of the market, without Opec cuts or supply shocks, is expected to be a more gradual process, in which producers round the world start shutting high-cost barrels, while demand growth picks up in response to lower prices. Currently, the market consensus is that will happen towards the end of 2015 or early 2016.
Why has Opec been on a wait-and-watch mode and kept production levels unchanged despite the fall in oil prices? How soon do you see an intervention?
Opec’s decision to keep to its 30-million-barrels/day production target and statements by Ali Naimi, the Saudi oil minister, dismissing any suggestion of a cut make the probability of the organisation revising its stance seem remote. The consensus market view seems to be that Opec is determined to ride out the storm and defend its market share, in the hope that lower oil prices will automatically squeeze the marginal cost barrel from the market.
What could trigger a trend reversal in oil prices?
Geopolitical threats on major producer regions such as West Asia and North Africa have the potential to choke supplies at any time. Libyan crude production continues to be volatile; after recovering to about one million barrels/day at the end of October, it recently dropped to well below 400,000 barrels/day, amid increased violence.
Islamic State continues to be a threat in Iraq and Syria. The conflict between South Sudan and Sudan remains to be resolved and has already curtailed about 30 per cent of the production in the South. Attacks on oil infrastructure are a constant in Nigeria, and the government has cut its oil production estimate for the 2015 Budget to 2.28 million barrels/day from 2.38 million barrels/day for 2013-14.
What are your forecasts for oil & gas production and consumption for 2015 and beyond? How does it compare with the past few years? Have you scaled down estimates, given the road ahead for global growth?
Bentek (the analytics unit of Platts) is confident in its expectation of oil & gas production growth in 2015. There could be some variability between 2016 and 2019, depending on prices. A fall in oil prices below $70/barrel (bbl) could force operators to cut capital expenditures and slow-drilling operations.
While 2015 is setting up to be another banner year of growth for both crude oil and natural gas, the real risk to production growth lies in 2016.
A breakeven price analysis suggests WTI (West Texas Intermediate) must fall below $70/bbl to force a drop in capital expenditure so that fewer oil wells are drilled. In an aggressive scenario, a 50 per cent fall in new wells drilled will result in flat oil production from six major oil plays by 2019 and flat natural gas production from those plays. This 50 per cent drilling curtailment will take three million barrels/day of expected growth from the market.
For natural gas, given growth in other natural gas plays are not as reliant on oil prices, production will continue to increase, despite a weak oil price environment. However, higher natural gas prices might result from weaker associated gas production.
Brent crude still enjoys a substantial premium to WTI. What explains this, especially at a time when oil prices have been under pressure? Do you see the gap narrowing?
The front-month Brent/WTI spread has steadily narrowed for most of this year, starting at a high of $15.14 in January and falling to as low as $2.14 in mid-October. Overall, this spread is narrower than in previous years, with Brent’s premium over WTI averaging $6.58 so far this year, according to Platts data. That is the narrowest the spread has been since 2010, when WTI was valued over Brent for 105 of the 251 trading days and the annual spread averaged 75 cents.
While Brent prices, as the global sweet crude benchmark, are responding to the global oil oversupply against lacklustre demand, WTI prices reflect the burgeoning US tight oil supply and refiner demand for crude within the country. The US Energy Information Administration, in its December short-term energy outlook report, projected WTI’s discount to Brent would widen from current levels to an average of $5/barrel in 2015.
Much has been spoken of shale gas and how it could replace oil. What are your views on this? If oil prices continue to remain low, how long and till what levels will shale gas production be viable?
Bentek expects lean gas production will remain mostly flat due to a bearish view on natural gas prices. It expects gas production from natural gas liquids and oil-focused plays to account for almost all the growth in gas production by 2018, but expectations of natural gas growth will depend on a healthy price for oil.
If the WTI benchmark remains above $70/bbl, associated gas production will account for more than half the US natural gas production by 2016. If domestic oil prices weaken to levels below $70/bbl and discourage drilling in the major oil and liquids plays, natural gas production growth could slow, too.
However, more natural gas supply could come online from shale plays that are currently unfavourable due to weak gas pricing. Shale gas plays such as Haynesville will again become economic around a sustained price of $5.00/million British thermal units if associated gas production is taken offline.
Do you see the fall in oil prices as a threat to India’s economic recovery in 2015?
In general terms, the oil price rout is a major advantage to countries such as India, which import a substantial proportion of their crude needs, and where oil demand is growing. The convergence between market prices and government-regulated gas-oil prices provided the government just the right window of opportunity to end gas-oil subsidies in October. Budget savings from the elimination of fuel subsidies can possibly be redirected to areas that contribute to economic growth.
What are the implications for Indian oil and non-oil companies?
The elimination of fuel subsidies is largely advantageous to downstream companies, the public sector undertakings that refine and market oil in India. In addition to sharing some of those losses, the reimbursements from the government were not regular and timely, which strained companies’ finances. But the bottom lines of refiners are dictated by their refining margins --- the differential between their crude costs and their refined product sales prices.
Though refining margins across the world steadily rose in tandem with plunging crude prices, a resulting rebound in refinery throughputs in November merely shifted the oversupply from crude to products. The start-up of new refineries in the coming months could exert pressure on margins.
With regard to the upstream players in India, the gas-oil price deregulation will, undoubtedly, provide some relief because these shared some of the fuel subsidy burden. But more importantly, these companies will be hit by lower revenues from oil production.