Despite risks, outlook for oil price is bullish

After 24 Opec and non-Opec countries agreed to extend their output cuts through the end of March 2018, the oil price plunged by as much as 5 per cent on Thursday, then rallied by 3 per cent on Friday.

Given this volatility, what is the short-term outlook for prices if producers hold to current levels of output?

The outlook is bullish, although some dangers do lie ahead.

The key bullish factor is that with the agreement to extend the 1.8 million barrel per day (bpd) cuts, oil inventories should start to be drawn at a rate of 1 million to 2 million bpd during the second half, according to the International Energy Agency and the Opec Monthly Oil Market Report (MOMR).

Stocks drawdown has already started but did not show up much in OECD statistics because Opec countries have been selling floating storage and other non-OECD inventories have been reduced, according to the IEA.

The market should tighten significantly over the next few months because June will see Saudi exports fall sharply, as oil minister Khalid Al Falih pointed out on Thursday. Summer air conditioning demand will divert a lot of heavy oil to electricity generation.

Around the world refineries coming out of turnaround are ramping up throughput by 2.7 million bpd in the summer, according to the IEA. This will come just as supply side sales are tightening. Prices might even overshoot into the US$60s per barrel.

But this is dangerous territory for Opec because US shale companies will be able to hedge more at these levels and add to the 820,000 bpd by which the MOMR expects US total production to rise this year after falling by 710,000 bpd in 2016.

Also, $60 seems a key level for sources hit hard by the declines in 2014-2016. Deep offshore oil is viable above that level and there are many discoveries around the world awaiting development under the right economic conditions.

New Canadian oil sands projects here in Alberta, from where I am writing this column, are also viable above that US dollar level on West Texas Intermediate at Cushing. Medium term, the Keystone pipeline approval by the Trump administration could knock $6 per barrel off that break-even, compared with rail transport, once the Alberta-Nebraska section is completed.

A total of 1.8 million bpd deliverability will be created by Keystone plus the expansion of the Trans Mountain Line to the Pacific and the Enbridge Line 3 upgrade to the US Midwest.

This will be enough to permit two decades of expanding output in the Alberta oil sands.

New technologies are also reducing greenfield project costs on a number of fronts, according to a CIBC institutional investor study reported in the latest Alberta government Oil Sands Industry Quarterly.

“Streamlined projects” could knock up to $10 per barrel from $65-70 per barrel prospects sitting on the shelf, while the substitution of solvents for steam in tapping deeper sands could lower costs below $50 per barrel in the next five years.

Various methods of extracting the asphaltenes from oil sands crude are being introduced, which eliminate the need to dilute the heavy oil with 25-35 per cent condensate to pipe it to markets. This might reduce costs by a further $10 per barrel some time in the next decade.

Of course, this is not an immediate threat to Opec, but Canadian production this year is forecast by the MOMR to rise by 220,000 bpd due to an additional 270,000 bpd of oil sands offsetting conventional production decline.

Extension of the Opec cuts is aimed at offsetting an MOMR projected 950,000 bpd rise in total non-Opec production this year. Russia wanted the 1.8 million bpd of combined cuts extended for a year to ensure a firm price during its presidential elections next March, but for others this was a bridge too far.

As it stands, firm prices for a further nine months will be a big temptation to cheat for countries such as Iraq, which continues to build capacity and complains that it is having to shoulder nearly all the cost of defeating ISIL. Further potential erosion of the theoretical cuts is the exemption of Libya and Nigeria to make up for political strife interrupting normal output. The IEA pointed to preliminary indications of 800,000 bpd of Libyan output, compared with an average of about 400,000 bpd in 2016.

There is no doubt that Riyadh is driving the whole cuts policy, actually overfulfilling their contribution to ensure 90 per cent Opec compliance. Clearly in their sights is ensuring a successful $100 billion initial public offering for 5 per cent of Saudi Aramco slated for 2018.

Jim Crawford is the general manager of Inter Emirates General Trading in Sharjah.

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