April oil price gains confound predictions – but volatility ahead

The US government’s Energy Information Agency has forecast domestic oil output will fall in the third quarter of this year. Eric Gay / AP Photo

The strength of oil prices in April has confounded many predictions – and industry experts are forecasting price volatility ahead amid a stuttering demand recovery and unpredictable reactions from oil producers.

The world benchmark North Sea Brent crude oil futures had gained nearly 16 per cent from the start of April, ending last Friday in London at US$65.28 per barrel, with the week’s 3 per cent gain adding to the momentum.

Many analysts had predicted that the first quarter of the year would involve continued price weakness, as the refinery maintenance season added to the market's woes, with Brent futures having collapsed from a high last summer around $115 per barrel to a low point in mid-January of $46.59, chiefly because of booming oil production in the US and Opec's unwillingness to respond with output cuts.

The unexpected price recovery this year has been put down to a number of factors, including stronger-than-expected demand for refined oil produces, including petrol and jet fuel, partly in response to the lower prices. Tensions in the Arab world have also been a factor, even though there has been no sustained oil supply disruption – for example, production in both Libya and Iraq was significantly higher last month, according to the International Energy Agency, even though fighting in both countries intensified.

The civil war in Yemen, drawing in support for rival proxies from Iran on one side and a Saudi-led coalition on the other, has exacerbated regional tensions but has not caused any serious disruption to oil trade.

But the consensus last week at the big annual industry gathering in Houston – IHS CeraWeek – which attracts chief executives from most of the big oil companies, is that there is more pain to come, and especially more price volatility.

The chief executive of ConocoPhillips, for example, said that while marginal production has been forced off the market in recent months – as evidenced by slowing growth in US oil production – any oil price increases in the near term would only tempt back that output.

“If they get a price signal that a high price is coming back you’ll see more supply come back on and that certainly has the opportunity to exacerbate the problem,” Lance Ryan, the ConocoPhillips chief, said in Houston. “As we look forward over the next few years, we see a more volatile world.”

Several top oil executives pointed to a prolonged period of lower prices, which they said should force down industry costs.

The effect of lower oil prices is already evident. The biggest three oil services contracting companies – Halliburton, Baker Hughes and Schlumberger – have announced combined job cuts of 40,000 between them. Cuts in capital expenditure from the likes of ExxonMobil, Chevron and BP have ranged from 12 per cent to nearly 30 per cent.

The US government’s Energy Information Agency has forecast domestic oil output will fall in the third quarter of this year – the first quarterly fall in four years – by 200,000 barrels per day, to 9.15 million bpd, as the market responds to lower prices. But the EIA forecasts production rising to about 9.6 million bpd by the end of next year as prices recover.

There is still some way to go in forcing down costs, according to Bob Dudley, the BP chief. “The cost structure in the industry is clearly off in this price environment,” he said. “I do think the industry needs to prepare for lower [prices] for longer.”

Rex Tillerson, the ExxonMobil chief executive, made a similar point after noting that a sharp drop in the number of oil rigs after the 2008 financial crisis rebounded quickly. “People need to settle in for us to be in a different price environment for at least the next couple of years,” he said.

“You’ve got to be ready to survive at $60 a barrel oil, maybe less,” echoed Stephen Chazen, the chief executive of Occidental Petroleum.

The uncertainty about Iran sanctions negotiations increases the likelihood of volatility. The EIA reckons Iran has 30 million barrels of crude oil in storage and could add production capacity of 700,000 bpd by the end of next year. But the pace of its oil coming back on to market depends on the terms of a deal over its nuclear programme, which is expected to be finalised by this summer.

An Iran deal could have implications for US oil production, according to Lisa Murkowski, a Republican senator from the oil-producing state of Alaska who is also chairwoman of the senate’s energy and natural resources committee.

She told a Houston meeting that she would push for a lift of the ban on US oil exports in return for support for a deal on Iran.

“We shouldn’t lift sanctions on Iranian oil while we are keeping sanctions on American oil,” Ms Murkowski said at a panel discussion. “It makes no sense.”

A law prohibits the export of US oil without a special permit, which has only been given in very limited circumstances and mostly been used for re-export of Canadian crude oil. A change in that law could result in a sharp increase in oil flowing out of the US to European and Asian markets, which would exacerbate a market already in glut, especially with US oil in storage currently nearly at capacity.

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