Oil registered a third weekly gain as the US imposed fresh sanctions on Iran after a missile test and Opec reached about 60 per cent, or 840,000 barrels per day, of its output-cut target, according to a Bloomberg survey.
Opec and other exporters agreed last year to reduce supplies by a combined 1.8 million bpd to prop up prices that remain at about half their mid-2014 levels.
After posting the biggest annual gain in seven years in 2016, oil has fluctuated in the mid-US$50s as Opec implements cuts. Oil producers from Saudi Arabia to Venezuela have implemented cuts and Russia says it is ahead of schedule with its own reduction. However, rising output from those not included in the accord – Libya, Nigeria and Iran – and from the US might undermine the effectiveness of the deal.
US crude inventories rose last week by 6.5 million barrels to 494.76 million barrels, the Energy Information Administration said, far exceeding forecasts for an increase of 3.3 million barrels.
Saudi Arabia has cut output by even more than it pledged. Some analysts expressed doubts that Iraq would deliver its share of the cuts, potentially undermining the drive to rebalance the market and drain inventories stuffed by two years of unconstrained production that helped to crash prices. Rising supply from the three countries excused from the agreement could offset the cuts made by the rest, reducing the size of the overall reduction in Opec output to little more than 800,000 bpd. This remains to be seen.
Thus far Saudi Arabia has reduced output more than it was supposed to under the November agreement. Once domestic consumption begins its seasonal demand towards its summer peak, Saudi output will have to rise to maintain exports. Energy subsidies will later this year, once again, be reduced and consumption will begin to be affected, as it did, albeit marginally, in 2016. So Saudi Arabia is right, like all other Gulf oil producers, to reduce energy subsidies.
Crude inventories in the US, the world’s biggest oil consumer, have been near record highs for much of the past year and domestic production is rising as US companies drill for shale oil. Investors are also considering that US shale drillers are boosting activity and their break-even price looks competitive even with oil below $60 per barrel.
In a report by Wood MacKenzie, projections of break-even shale oil prices for the upper end of the wells in North America and the Gulf of Mexico is in the low $70s. Not too long ago, the break-even prices in shale basins were estimated to be above $80 per barrel or, for some, even $100.
The reality on the ground is more complicated, however, than simply the break-even price of shale. Transport costs can vary widely depending on where you’re drilling, where your refining customers are and whether the oil is being shipped by pipeline, railcar or lorry.
As per industry practice, drillers in the Bakken have an average break-even price of $52 per barrel. Add on top another $5 for overhead and interest charges and assume the oil is being sent from North Dakota to refiners on the Gulf Coast by railway at $10 per barrel. The all-in break-even price for that barrel is $67. If there is space on a pipeline available, then that comes down to maybe the low $60s.
Take Dakota Access, for example. If Donald Trump’s signature clears the final barrier to completion, then the pipeline could be up and running later this year. Assuming 90 per cent utilisation, it could carry 450,000 bpd from the Bakken shale basin towards refineries on the Texas coast, according to Wood Mackenzie. Bakken output has been falling since December 2014 as E&P companies have shifted focus to lower-cost regions such as the Permian basin in Texas.
The confluence of more pipes and better overall infrastructure for transporting oil as well as a new tax policy in the US will increase oil output to almost double by 2018, according to Goldman Sachs. Moreover, higher oil production will lead to extra gas, which will also affect prices.
Opec’s room to manoeuvre and provide additional cuts will be put to the test. It takes a short time to develop shale resources, relative to conventional oilfields, and the E&P’s access to funding is important for the next round of fighting over market share and pricing.
Clayton Williams Energy is a case in point, with its resort to private equity and now a cash-and-stock acquisition taking its share price from $7 to $140 in the space of less than a year. Clayton Williams Energy is a Texas oil producer and an early user of horizontal drilling, which would later enable hydraulic fracturing, or fracking.
For the oil-producing countries of the Gulf, the adjustment from lower oil revenues is taking place, for some more abruptly than others. However, the fiscal adjustment should neither be too harsh nor too quick, as reiterated in previous editorials. Although an economy is not akin to a company it is in some ways akin to a family’s household, at least on the expenditure side. In more difficult times it has to cut down its spending but not to the extent of jeopardising its livelihood. Excess spending, however, can always be reduced. And a family is part of a larger system that entices the economy to grow or contract. Gulf economies will have to continue to adjust to lower oil revenues as the battle ensues.
John Sfakianakis is the director of economic research at the Gulf Research Centre in Riyadh
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