Oil prices set to remain weak, amid continued oversupply
The global oil market is hardly known for its stability; in the last decade alone, the price of dated Brent blend, the international benchmark, has spiked to around US$100/barrel and fallen back around US$30/b on two separate occasions.
However, while a certain degree of volatility has become the norm, the fluctuation of global oil prices in the first half of 2017 has been remarkable, as it has challenged some widely-held assumptions about the structure of the global oil market.
Oil prices hit a seven-month low in mid-June, effectively erasing all of the price gains made since November 2016, when OPEC countries and 11 other non-OPEC producers agreed to cut their collective output by 1.8m barrels/day (b/d).
Compliance with the cuts has reached record levels thus far, but this has not been enough to drive sustained rise in global oil prices, confirming that the oil market is undergoing an important shift.
OPEC’s ability to influence oil prices is slipping
OPEC’s ability to shape global oil prices has always been indirect, as a number of other factors, including the level of global stocks and fluctuations in demand, can offset these efforts.
Nonetheless, in recent decades at least, OPEC’s position has been strengthened by the fact that its cartel-ised structure allows it to make and implement collective decisions in an attempt to influence prices.
In addition, OPEC’s share of global oil production rose from around 30% in the mid-1980s to an average of over 40% in 2007-11, meaning that shifts in the bloc’s production strategy have had a clear impact on global supply.
However, soaring oil prices in 2007-08 and again in 2011-13 helped to encourage the rapid expansion of the US oil industry, which pushed OPEC’s share of global crude production back below 40% in 2014-15.
OPEC countries still account for a considerable amount of global oil reserves, and The Economist Intelligence Unit forecasts that the bloc will continue to represent around 40% of total production for the next five years, despite the rapid recovery of the US oil industry.
However, even at this level, OPEC’s ability to influence oil prices is waning.
The November 2016 production-cut agreement helped to boost confidence that the oil market would come back into balance in the near term.
The price of Brent crude shot up from under US$47/b in November to US$54.5/b on December 2nd, before holding at a steady average of US$55/b in January and February 2017.
Since March, however, prices have fallen sharply, as US oil production has risen more quickly than expected, output from OPEC countries that are exempt from the agreement (including Nigeria and Libya) has unexpectedly recovered, and as global oil stockpiles remain well above the recent five-year average.
These factors have undermined OPEC’s ability to set the direction for global oil prices.
Shale producers were down, but not out
The two-year slump in global oil prices, which saw Brent crude prices bottom out at close to US$28/b in January 2015, had a dramatic effect on US shale producers.
However, the rapid increase in US shale production in recent months has confirmed that these companies were able to shed costs in order to survive the crisis.
This makes them even more competitive in the current price environment, which is a major concern for OPEC.
US oil production fell to an average of 12.5m b/d in 2016 as persistently low oil prices prevented cash-strapped and indebted shale producers from making the necessary investments to sustain output.
However, rising futures prices of West Texas Intermediate (WTI), the US benchmark, in mid-2016 enabled many shale producers to hedge future output, leading to a rebound in investment in 2016 that has already begun to be reflected in US production numbers.
The EIU expects US oil production to expand by 5.5% in 2017, to 13.2m b/d—the main factor offsetting OPEC’s attempt to re-balance the oil market.
Oil prices’ rise to over US$50/b in early 2017 has returned a number of shale wells to profitability, encouraging a further boom in investment.
The US oil-rig count, compiled by Baker Hughes, rose to 916 active rigs in early June, up by 125% from the same point in 2016.
There tends to be a six-month lag between shifts in the rig-count and the impact on real output levels, so recent investments will continue to have an effect in 2018, when we expect production to grow by 3.7%.
Overall, The EIU forecasts global oil production to expand by a modest 0.8% in 2017, as OPEC sticks to its production quotas.
However, global oil demand has been growing at too slow a rate—we forecast consumption growth of 1.4% in 2017, down from 1.7% last year—to make a significant impact on the market.
Although we expect the market to reach a fragile supply-demand balance by end-2017, this will only scratch the surface of ample global oil stockpiles, setting the stage for another, albeit more modest, drop in global oil prices in 2018.
Cailin Birch is a senior commodities analyst at the Economist Intelligence Unit
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