Robin Mills: New test awaits oil as prices rise

Oil prices, which dropped to as low as US$27.50 per barrel in January, rebounded to close to $50 per barrel last week.

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Clouds of smoke from wildfires hang over the Canadian town of Fort McMurray; oil leaks from sabotaged pipelines at Nigeria's Forcados terminal; Venezuela runs out of money to buy oil to mix with its own heavy crude for export; Kuwaiti petroleum workers go on strike over pay; and an Indian tanker is turned around after attempting illegally to export oil from eastern Libya.

These five disparate incidents are linked in two ways. They, and other disruptions, have removed about 2.5 million barrels per day of oil supply, bringing the market closer to balance after two years of glut. Oil prices, which dropped to as low as US$27.50 per barrel in January, rebounded to close to $50 per barrel last week.

But there is also a deeper connection. The forest fires in Alberta are a natural disaster that might happen at any time, but the other disruptions are all linked to low oil prices.

The situation in Nigeria appears most serious. The government has halted payments to Niger Delta militants, leading them to resume a campaign of sabotage, while plans to cut fuel subsidies have encouraged strikes by labour unions. Prominent politicians remain in cahoots with oil smugglers and gangs.

Such paroxysms of violence have broken out before, particularly with serious production interruptions in 2008. But alongside the continuing Boko Haram insurgency in the north, the weak fiscal situation leaves the authorities with less room to broker deals. Not only is the price down, but with a budget based on 2.2 million bpd of production, actual output is now 1.4 million bpd – the lowest for 22 years.

In Venezuela, the drop in oil revenues has exposed years of mismanagement, leaving Caracas struggling to pay its bills and even keep the lights on.

Kuwait’s pay cuts were part of a government cost-saving drive, while the attempted illicit Libyan oil exports might have been part of the eastern government’s attempts to pay its bills.

Elsewhere, the reduction in oil revenues has combined with long-standing corruption and mismanagement in Baghdad and the Kurdish region to trigger political crises and a halt in oilfield investment as international contractors go unpaid.

Other vulnerable spots could include labour or political unrest in Kazakhstan, Azerbaijan and Algeria, or a deepening of the crisis in Venezuela.

Safety margins have grown thin. The Saudis hold about 2 million bpd of spare capacity, but otherwise only the UAE and Kuwait have much output in reserve.

However, the lack of spare capacity is offset by enormous quantities of oil in storage: 3 billion barrels in OECD countries alone, a month of all global consumption; plus further large amounts in developing countries. China, in particular, has taken advantage of low prices to build its strategic stocks. For now, this should prevent prices from rising too quickly.

Some of the disruptions are being resolved, as a deal has been reached to reopen the Libyan port of Marsa El Hariga; work at the Canadian oil sands will gradually resume; and a blockade of Nigeria’s Qua Iboe port seems to have ended.

The futures price – for oil to be delivered in a few months’ to several years’ time – allows companies to decide whether to drill. US shale companies, in particular, can lock in prices for a year or two and guarantee the profitability of their wells. The Brent crude futures prices, now above $50 per barrel, might be reaching high enough levels to encourage some shale drillers to restart activities.

Below the break-even point of most shale companies, prices can be highly volatile, as so far this year. With higher prices, the combination of swollen inventories and nimble shale drillers should mute the impact of further disruptions. We are about to undergo an unexpected test of the resilience of our novel oil market.

Robin Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis.

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