It seems oil prices remain stuck in a very tight range and, more recently, in a bearish trend. The lateral range of $50-55 was recently broken and the new long-term support level is closer to $47 than $50.
There are various reasons for this.
a) The OPEC-non OPEC deal is unsustainable. We read everywhere that compliance to the cuts is 90%, but this hides the fallacy of averages. Saudi Arabia is reducing output by a lot more than agreed (130kbpd cut above its agreed production), while Russia is at almost a third (118kbpd vs 300 agreed), Irak is also well below (85kbpd vs 250kbpd agreed), and Emirates, Kuwait, Venezuela, Algeria… all are between 50 and 60% compliance on the agreed cuts. Only Angola, out of the rest of the list ex-Saudi, is cutting more than announced. This reliance on Saudi Arabia doing all the work -again- will end up badly… as always.
Iran keeps pumping at record levels and Iraq is rising to record highs. Oil exports in February reached 3 mbpd, a level not seen since 1979. According to the IEA, Iraq will increase its output to 5.4 million barrels per day by 2022, which is significantly higher than the earlier estimates of an increase to 4.6 million bpd by 2021. Similarly, Iran is expected to boost production by 400,000 bpd to reach 4.15 million bpd production in 2022. These barrels are not only of mugh higher quality (Iran is very light crude), but more abundant as reserves have been underdeveloped for years.
b) US production is rising faster and stronger than expected. US oil production has increased by 400kbpd from the lows, surprising consensus and most international agencies, that thought that shale would not recover before Brent reached $65. According to Chevron, shale breakeven is now at the high $30s-low $40s, and OPEC has underestimated the process of strengthening balance sheets and improving the efficiency of the US companies. This is before any tax cuts from the new administration, that would lower the breakeven price even further.
c) Inventories remain elevated. At 66 days of supply, OECD inventories are at a 6-year high (55 days inJanuary 2011) and above the historical high end of the range (65 days). US crude inventories have soared as well, to a new record high. Crude inventories rose 8.2 million barrels in the week to March 3, compared with analysts’ expectations for a 2 million-barrel build.
d) Lack of “investment” is just the burst of a bubble. While many point to capex cuts as the driver of a new super cycle, few seem to understand that the monstrous increase in capex in Oil and Gas from 2004 to 2013 was created by the bubble of low interest rates and perception of ever-rising oil prices, not demand. Capex multiplied by more than three in real terms to more than $1 trillion per annum in a decade of excess, creating a very high level of structural overcapacity, close to 20%.
e) Demand and the USD. Oil demand growth estimates look, yet again, too optimistic. As we have seen almost every year since 2001, international agencies get used to correlations of growth and oil demand that simply do not work and have been broken for years. Efficiency, technology and substitution continue to improve exponentially, eating away the equivalent of one Sweden of potential demand growth every year. This technology and substitution has not stopped due to low oil prices, as OPEC expected. Solar, wind, electric vehicles and other alternatives continue to thrive despite lower fossil fuel.
A stronger US dollar and the Trump administration’s policy of “America first” also destroy the geopolitical premium attached to the oil price. The US can become fully energy independent by 2019, and a monetary policy that finally ends the destruction of currency as a target also supports a strong dollar that impacts the barrel, which trades in the US currency.
Even if the reader wants to hang on to bullish price expectations, you should agree with me that if oil prices remain rangebound despite the largest cut in history, it is because the market is not only very well supplied. It remains oversupplied.
Daniel Lacalle. PhD in Economics and author of “Life in the Financial Markets”, “The Energy World Is Flat” (Wiley) and forthcoming “Escape from the Central Bank Trap”.
Image courtesy Google.