OPEC, against the odds, reboots global oil markets for 2018
'Exit strategy' from output cuts will bring a new challenge in the new year
What a difference a year makes. In the oil markets, it has produced a $10 a barrel rise in benchmark Brent crude, a well-engineered cutback of more than 1 million barrels a day in global oil supply and an estimated decline of 83 million barrels in OECD oil inventories in the first three quarters of 2017. Oil stocks had increased by 38 million barrels in the same period of 2016, adding to the world's glut for the third year in a row and pressuring prices down.
OPEC has risen from the ashes and vindicated the oil bulls. U.S. crude production has returned to growth territory after the first annual drop in eight years in 2016. However, much to OPEC's relief, U.S. output has perked up, not rocketed. The country's shale drillers, waiting for higher crude prices to pounce on more oil rigs a year ago, have adopted a new mantra: profits over production.
This year will go down as a transformative one in the global oil markets. It busted some assumptions and forced a reset of others.
OPEC's 14 members collectively pumped around 32.35 million b/d of crude in November, about 914,000 b/d lower than the same month of 2016, adjusted for Indonesia, which gave up its membership at the end of last year, and Equatorial Guinea, which became a member in May this year.
The reduction was less than the 1.2 million b/d pledged by the organization, but remarkably close to it, given that Libya and Nigeria, which are exempt from the production cut agreement, were pumping 490,000 b/d more in November compared with a year ago.
At the meeting in Vienna between OPEC and non-OPEC producers on Nov. 30, which extended the combined 1.8 million b/d of cuts by the two blocs to December 2018, Libya and Nigeria were asked to limit their combined output to 2.8 million b/d. That doesn't give them much leeway, as the two are already pumping close to that level. This was a deft maneuver to reduce the threat of an unwanted gush of new supply from the two OPEC members without getting into the tricky process of bringing them formally under the quota system.
The non-OPEC collaborators, led by Russia, also seem to have held up their end of the bargain through 2017, though production by the 10 countries in this group is harder to pin down and under relatively less scrutiny. A joint OPEC/non-OPEC monitoring committee pegged the combined conformity with the production cuts at an unprecedented 120% in September.
Compliance is expected to remain strong in 2018. Russia and possibly a few other producers are keen to discuss an "exit strategy" from the cuts, which is likely to take the form of a gradual easing rather than an abrupt end, possibly in 2019.
The Saudi leader of OPEC's current market management strategy, Energy Minister Khalid al-Falih, will not want to rock the boat, at least not until the successful conclusion of the planned listing of Saudi Aramco, expected in the second half of 2018.
The OPEC and non-OPEC producers have also received help from an unlikely quarter. U.S. crude production growth turned out to be far more moderate than initially expected. Output in 2017 is now projected to average a modest 383,000 b/d higher on the year, at 9.24 million b/d, according to the official Energy Information Administration. The most optimistic scenarios at the start of the year had suggested it could jump as much as 1 million b/d.
As the U.S. crude benchmark, West Texas Intermediate, slipped below the psychologically important $50 a barrel mark in April and languished in the low- to mid-$40s range through the second and third quarters, shale producers, who account for around 62% of the country's production, promptly reined in their spending. They cut back on oil drilling rigs through August, September and October after 14 straight months of adding new ones.
The sharp recovery in crude prices, starting in November, prompted a resumption of the market's anxious shale watch and sure enough, the U.S. oil rig count started creeping up again. However, the old rule of thumb that higher crude prices will drive proportionately more shale drilling and stronger production growth may not apply in 2018, as several major U.S. shale producers have recently indicated a shift in strategy toward greater financial discipline and higher profit margins.
Producers including Anadarko Petroleum, Devon Energy, EOG Resources and Pioneer Natural Resources, during their third-quarter earnings reports, vowed to increase free cash flow and dividends, instead of plowing money back into drilling new wells, in response to investor demands.
If the shale drillers stick to their new mantra, U.S. crude production growth may remain moderate next year, though the EIA is predicting a 780,000 b/d spike from this year to a record high of 10.02 million b/d in 2018. The last U.S. crude output peak was around 9.64 million b/d in 1970.
Meanwhile, hedge funds and other major speculators have been flocking to crude futures this year, amassing record-high net long positions, a sign of increasing bets on rising prices.
In the sheikh versus shale match, round one has gone to the sheikh. U.S. shale may still put a cap on crude prices for the foreseeable future, but OPEC has managed to secure a floor. Increasingly, that looks like $50 a barrel for Brent.
A $50 to $60 barrel band for crude, despite being half the levels producers enjoyed before the big price crash of 2014, gives OPEC members some breathing room. As supply becomes more balanced, expect more focus by oil watchers on demand in 2018. For producer countries and companies across the globe, the new challenge is to not just survive but thrive in the new normal.
Vandana Hari is the founder of Vanda Insights, which tracks energy markets. She has two decades of experience providing essential intelligence on the energy commodities sector.