For a few dollars more – OPEC’s shifting stance
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OPEC's plan for production cuts signals a desire to support prices, even if the battle to wrest control of the market seems barely half won. Low oil prices have affected global supply and demand, but the toll on OPEC economies is a decisive factor.
First, supply. The crude price halving has unequivocally put the brakes on future, conventional non-OPEC supply. We estimate 4 million b/d of production from pre-FID projects is lost to the market through project deferrals by 2021, 4% of global supply. This drives our view of a coming supply squeeze that pushes prices up to US$85/bbl (real) by 2020. These projects still need cUS$60-65/bbl break-even on average.
Existing non-OPEC production is declining, albeit by only 1 million b/d in 2016 from last year's peak. US onshore output is expected to fall by 1.2 million b/d peak-to-trough, two thirds of which is tight oil. Investment in uncons fell quick and steep, but production decline has been softened by high-grading, stunning efficiency gains and technology. The 'low' of 3.9 million b/d we now expect in Q4 2016 merely takes tight oil back to Q3 2014 production levels.
Tight oil has been quelled, not killed, and attention has already shifted to how production will respond to rising prices. Operators moved swiftly to put rigs back to work as prices moved above US$40/bbl in Q2 - the horizontal rig count is up 30% from the 2016 lows. Our Macro Oils team's latest forecast is flat production at best for calendar 2017, but underlying growth; 0.3 million b/d more output by end 2017 low to high, based on US$54/bbl Brent; and another 0.7 million b/d by end 2018.
Much more tight oil is in-the-money at lower prices than conventional plays. Most of the undrilled tight oil plays contributing to our forecast of 8.5 million b/d by 2025 are economic at US$60/bbl.
Outside the L48, the direction of non-OPEC near term production has tended to be down in 2016, but is trending upwards for 2017. Developments already underway pre-crash will continue to add supply through 2018 including Kashagan, Brazil and Canadian oil sands.
Russia too has new projects coming on stream, and growth from existing fields striving to boost cash flow to compensate for lower prices.
Second, demand. Saudi Arabia is acutely aware of the need to stimulate oil demand growth longer term in the face of increasing competition from disruptive energy technologies and climate change policy. Peak demand will come eventually, but can be pushed out – and all the more easily with lower rather than higher prices.
But that future is some way off. In the meantime demand growth has been the least of OPEC's worries – one dependable in an otherwise febrile market. Demand rose by 1.4 million b/d in 2015, and we forecast 1.0 million b/d and 1.2 million b/d respectively for 2016 and 2017. If there is any concern with demand, it's the lack of elasticity following the halving of price. OPEC may have concluded that finding the answer to that question can wait; and demand won't be much different whether the oil price is US$40 or US$60.
Third, the toll low oil prices have taken on OPEC economies. In Venezuela, the price effect is compounded by continual under achievement in production, symptomatic of its industry's current dysfunction. In contrast, Gulf producers, including Iran, have been producing full tilt to boost treasury revenues.
Even so, our Global Economics team estimates 2017 fiscal break evens well above the current Brent price for Kuwait (US$64/bbl), Iran (US$67), Iraq and UAE (both US$68).
Saudi Arabia (US$94/bbl) is higher still and has run down its foreign reserves from US$0.75 trillion in mid-2014 to US$0.56 trillion in July 2016 to plug the fiscal gap. All have cut spend and are reducing subsidies to varying degrees but still haemorrhaging cash. Saudi's plans for deeper structural reform are unfolding but will be some years in the realisation.
IOCs have led the way in the downturn, halving the average corporate cash flow break even price to US$53/bbl in 2017. OPEC producers could take a leaf out of their book: balance expenditure to revenue and make economies robust for lower (as well as higher) oil prices. But the cogs of state take longer to turn. In the meantime, a few dollars more on the oil price would ease the economic pain, likely without stifling demand and triggering a new wave of cyclical investment.