Three years on from the crash

What are the near-term prospects of recovery? Who have been the winners and losers? How long can OPEC cope at current prices?

It's three years since the oil super cycle ended – happy anniversary! Brent entered July 2014 at over US$110. By the end of the month, crude was sinking, as OPEC began its journey towards a strategy of market determined price. 2017 is set to be to be the third year Brent has traded at under half those heady levels.

Too much supply is a dampener on any sustained price recovery near-term. More volume is coming onto the market from OPEC (Libya and Nigeria) and non-OPEC (US tight oil), threatening the pace of market rebalancing through 2017 and 2018.

Global supply will increase by 1.9 million b/d next year without an extension of the OPEC agreement to cut production beyond March 2018. We forecast demand growth at 1.2 million b/d. There will be oversupply and sustained downward pressure on prices.

OPEC to take action

We think OPEC, supported by key non-OPEC producers including Russia and Oman, will be stirred into action to avoid calamity.

Production cuts will be extended by another nine months through to end 2018. Even with cuts, there will be limited market rebalancing, and inventory will remain stubbornly high. Recognising the downside risks for the next two years, on 10 July we lowered our price forecasts by US$2.50/bbl for each of the next two years to US$51/bbl in 2017 and US$50/bbl in 2018. The downturn looks set to stretch from three to four consecutive years of prices around US$50/bbl. Lower-for-longer is becoming a reality.

The strength of current supply shows how little effect the halving of price has had on near-term production. Operators around the world have pulled all the levers to maximise cash flow, and keeping the oil flowing where profitable is one of them.

Dozens of individual countries have experienced a fall in output, cumulatively adding up to 2.9 million b/d. Three contribute more than half: the USA, down 1.0 million b/d (mostly L48 conventional and tight oil operating at the marginal cost of global supply); Mexico, down 0.35 million b/d (investment cuts by Pemex); and China, down 0.26 million b/d (NOCs focusing on value over volume).

But there have also been relative winners too, offsetting the losses. A handful of producers have managed to increase production by a total of 1.1 million b/d. Among these few, Russia up 0.45 million b/d is much the biggest (margins boosted by the weak rouble); with Canada next, up 0.17 million b/d (execution of incremental oil sands projects).

Limitations to producing fields 

The economic imperative for producers is still to generate cash flow, but there are limits to how far producing fields can be 'stretched'.

The lack of upstream investment outside US tight oil will start to tell. Production declines accelerate from 2020 across most of non-OPEC.

OPEC has filled the near-term gap, increasing production by a net 2 million b/d since 2014. Iran, Iraq and Libya are all substantially up as they rebuild supply. The rest of OPEC is down, mainly a result of the production cuts.

The combination of lower production and a low price is proving difficult for OPEC members. Fiscal breakeven for Middle East producers is in excess of US$70/bbl on average, even with government spending restraint. Any short fall is funded by running down official reserves, tapping international capital markets, or finding tax revenues from elsewhere which takes time.

Saudi Arabia's treasury reserves, for example, have fallen by one-third from US$0.75 tn in 2014 to US$0.5 tn in May 2017 (IMF/SAMA). There is still much in the kitty (and borrowing is also an option), but were Brent to remain at today's price, we estimate reserves would run out by the mid-2020s, all things equal.

The incentive for OPEC to bring about market rebalancing and firm up prices is all too clear. At the same time, the stats underline the importance of the economic restructuring underway should market tightening remain elusive and lower-for-longer persists.