Opec stance helps reduce oil glut, but more action needed

Market is rebalancing, prices gradually returning to equilibrium.

In spite of a recent pickup, oil prices remain around 40 per cent lower than last year. The global oil market continues to be in surplus, led primarily by the US.

Crude inventories in the US were at all-time highs in March after hitting 474 million barrels, about 20 per cent more than twelve months ago. The Organization of Petroleum Exporting Countries (Opec), which produces around a third of world supply, has also been contributing to the supply glut. Following its semi-annual meeting last week, the group concluded that it would not shift away from its current strategy and that it would maintain production to gain global market share.

More importantly, Opec members, whose mixed opinions tend to hinder decision making, reached consensus fairly quickly this time around. Today, it is someone else’s turn to cut production in order to boost prices.

Higher cost producers will be the first ones to feel the low oil prices and cut production. According to Morgan Stanley, the price of Brent crude oil needs to be above $65 per barrel for the average North American shale company to be profitable. The crude oil cost of production is only on average higher when extracted from oil sands, such as in Canada ($70) and the Arctic ($75). In stark comparison, the average cost of onshore production in the Middle East is only $27 per barrel. In cost terms, Middle Eastern countries, who dominate the Opec, are very well equipped to withstand an environment of low oil prices.

Opec’s strategy is working. In the US, shale oil wells production declined last month and drilling rigs fell by a substantial 60 per cent since October. Crude stocks have peaked and have fallen for the last six consecutive weeks. Additionally, a large number of these companies have cut investments. This phenomenon is happening around the world, with more than $100 billion of capital spending having  been affected negatively according to the Financial Times.

Morgan Stanley projects the decline in capital spending of 120 companies to fall by a quarter in 2015, from $520 billion to $389 billion. In the meantime, oil prices have recovered from year-start lows, gaining around 15 per cent in the last six months, just enough to boost Opec members oil receipts while still hurting high-cost producers.

The market is rebalancing and prices are gradually returning back to the equilibrium mark. So far this month, the price of Brent has remained between $60 and $65. Given the current environment, and assuming no change in Opec stance, prices should continue to make their way higher. Nevertheless, global demand weakness will limit the strength of the price recovery.

The market is still in a glut, and the oil producing group must remain patient and maintain its strategy in order to enjoy higher prices. According to Morgan Stanley, the price of Brent will recover to $85 in 2017, an optimal price for the low-cost producing countries.

 

The writer is economist at Asiya Investments Company. Views expressed by her are her own and do not reflect the newspaper’s policy.