)
What is your outlook for Brent crude in 2015, given that Opec decided last month not to cut output?
The outcome of the Opec meeting marks a watershed for the oil market. In keeping the production target at 30 million barrels a day (b/d), it clearly signalled that it would no longer bear the burden of market adjustment alone. The decision puts the onus on other producers, especially the US, to adjust as well. The absence of even a limited pledge on tighter compliance with the targets is worth noting in their statement, as well as the shift in intent from Saudi Arabia (premier in the cartel), in moving away from suggesting preferred price bands to letting the market balance itself.
Over the coming months, oil markets will have to find a new equilibrium, a world where demand elasticities are tested, and non-Opec supply sensitivities, particularly the pain threshold for US producers, becomes better understood. At least another million b/d of cuts looks necessary to balance the market, in our view.
Opec's signal, to share the burden of adjusting the supply, broadens the range of fundamental levers that need to be adjusted in balancing the market. Oil prices could move below $60/bbl in the near term. However, this is not sustainable in the long run, as it would place considerable strain on the cost curve of the unconventional supply system required to meet the demand requirements in 2016 and 2017. We expect Brent prices to average $67/bbl in the first half (H1) of 2015, and $78/bbl in H2.
Why hasn't Opec cut production, given that the demand is not showing sign of a pick-up, while supplies have increased from non-Opec countries?
Its key members are concerned about losing market share, at the expense of rising non-Opec supply, predominantly from North America. Going into the November meeting, Saudi Arabia had broadly two choices. The first one was to cut production and reduce the surplus in the markets, with a possibility that this would shore up prices. However, this ran the risk that other suppliers within and outside Opec would step in the space left by Saudi Arabia. It also runs the risk of causing demand destruction -- part of the reason we have weak prices is because global oil demand growth has halved from a million b/d. The option they had was to let supply remain and let the market take its course in finding a new equilibrium. This would essentially help global oil demand growth recover, on lower oil prices. Especially when emerging markets are faced with depreciating currencies, weak economic growth and the removal of subsidies, as in the case of India, Indonesia. This would also mean the more expensive sources of supply, such as North American output, would have to adjust to the new price reality. Thus, helping Saudi Arabia maintain market share.
There are plenty of conspiracy theories doing the rounds, on how Opec is trying to drive crude prices down, so that the marginal capacities which have come up in recent years become unviable. There is also the theory of developed countries wanting to put pressure on Iran and Russia by depressing oil prices. Do you believe either?
Prior to the Opec meeting, the absence of outright policy guidance from Saudi Arabia, the key swing supplier in the oil market, left a void. This was filled with a range of assumptions. These ranged from politically motivated conspiracy theories to the extreme end of statements that suggested they (Opec) were losing their grip on the market. We don't subscribe to these views. Opec can still, if it chooses to, regain control over the market. What they have collectively decided to do by letting oil markets decide a new equilibrium is for lower oil prices to help demand, and also to possibly regulate the rapidly growing non-Opec supply.
Analysts believe politics has, for the first time, become centre-stage in determining oil price movements.
This isn't the first time oil has been used as a political tool.
Which are the biggest producers of crude oil and oil equivalent today? How will their capacities be impacted by the fall?
Saudi Arabia, Russia and the US produce a third of global oil supplies, roughly 10 million b/d each. Saudi Arabia has one of the lowest costs of production in the world. But their break-even is high, as they require balancing of their budget, due to high levels of domestic spending and defence-related expenses.
Although current prices are not favourable for Saudi Arabia, they are able to weather the pain, as they've built significant reserves over the past three years. Russia has a higher cost of production than Saudi Arabia and require a higher break-even price to sustain their budget. The additional sanction pressures have added to the country’s economic woes. This is being reflected in the rouble.
It is vital to note that in terms of falling oil prices and its impact, production growth is to be put in context. Rather than the quantity a country produces as base, it is the increment that drives the market. In this context, the past three years have seen North American oil production growth accelerate. There are growing concerns that lower oil prices will diminish this growth.
Do you think the shale boom is over?
Certainly not. The technology is here to stay. And, the spirit of entrepreneurialism that first accelerated this breakthrough supply, from the US, is still alive, now trying to reduce costs and become more efficient. We might eventually see a slowing in oil production growth but we won't see the sector as a whole vanish overnight. It will consolidate, reduce costs and improve technology, in the same spirit of entrepreneurism that has built it.
Though oil prices are down, China has been building a stockpile of crude. How much has China imported and how is that expected to impact prices?
China has been stockpiling crude oil significantly this year. Both to fill the second phase of its strategic petroleum reserve and to fill commercial storage facilities. This year, Chinese oil demand growth is only up around two per cent, while imports are up eight per cent. This difference has gone into stockpiling and in boosting refined product exports.
Both trends are expected to continue next year and will be supportive for prices. China has been active in the market this year and another fifth of its 343 million barrel commercial capacity is still unfilled, as is another 64.1 mn barrels in Strategic Petroleum Reserve (SPR) site capacity, planned for completion next year. Once this is filled, it would bring to a close China’s Phase-2 SPR at a total of 244.8 mn barrels.
Should India, too, look at building a stockpile of crude while prices are down?
India is bringing online its SPR in 2015. The timing is great, as India would be able to fill this at a cheaper rate than China’s first-phase SPR. India is also pursuing an alternative model with its SPR, which is lease-based. Roughly around 38.9 mn barrels is expected to be filled.
Do you think the boom in oil prices is over for the medium term?
Oil prices are forecast to remain under pressure for at least two more quarters. Over the coming weeks, the physical crude oil markets are expected to see refineries actively bidding, as their margins improve on lower crude feedstock. Opportunities to store crude offshore should also emerge. However, this is likely to lead only to crude being processed to be converted to refined product stocks, given that end-user demand is still not enough to absorb all the throughput. This has already started getting reflected in the product builds in the latest US Energy Information Agency data.
Once these product stocks get built, refinery margins will be under pressure, prompting refineries to be less active in bidding for crude, which could lead to lower oil prices than even the current levels. While prices might move below $60/bbl in the near term, this is not sustainable in the long run. It would place considerable strain on the cost curve of the unconventional supply system required to meet demand requirements in 2016 and 2017.
We expect Brent prices to average $67/bbl in the first half of 2015 and $78/bbl in the second half. The rebound in H2 hinges upon a demand recovery, some non-Opec supply adjustment, and some risks of supply disruptions in the Middle East/North Africa region.
