- Oil prices reach their highest levels in 2016 as a result of speculation and production disruptions
- Upward trend expected as market equilibrium is found thanks to stabilization of supply and persistant demand
- Forecast of end-of-year oil prices raised from 55 USD/bbl to 65 USD/bbl
Oil prices increase to 50 USD/bbl
At the end of May, oil prices increased to 50 USD/bbl, the highest price point in seven months. Oil prices bottomed in January, at 27 USD/bbl for Brent and 26 USD/bbl for West Texas Intermediate (WTI). The turning point occurred when several oil producers, among which Saudi Arabia, signalled that they would freeze oil production if its price would remain under 30 USD/bbl for an extended period of time.
The recovery of oil prices was mostly driven by two important factors: shifts of speculative positions, and temporary disruptions of oil production. The most important shift in speculative positions was the closing of short positions, mostly by hedge funds. The so-called CFTC non-commercial short positions (speculating on falling prices) reached an excessively high level in February this year (with almost 331,000 contracts). Ever since it became clear what the bottom was, the amount of outstanding short contracts decreased by more than 50%. Concurrently, the amount of non-commercial long positions has reached a record high. The bullish support can be attributed to a combination of speculation on future oil price hikes, and the purchase of these contracts by oil producers as a hedge on future oil production.
Temporary production disruptions also put an upward pressure on oil prices. Initially, a brief strike in Kuwait shielded the oil price from falling in the beginning of April, after the failed consultations in Doha, Qatar. Additionally, oil production declined as a result of sabotage in Nigeria; several pipelines of international oil companies in the Niger Delta were affected. Nigeria’s oil production then reached its lowest level in two decades. After the elections, unrest in Nigeria was fuelled by increased demands from the population to further benefit from oil production. Currently, 90% of the government’s income can be traced back to oil production. Unrest in Libya also flared up, further boosting oil prices. And finally, bushfires put a temporary hold on a significant portion of Canadian oil production. All of these temporary events had a positive effect on oil prices, despite the fact that global oil stocks levels are at a record high. And while it isn’t clear how long these production disruptions will persist, the effect of a low oil production contributes to finding a new equilibrium of supply and demand within the market, and thus also to the ‘normalisation’ of the oil price.
“OPEC will be powerful, will be strong. OPEC is alive.”
This is what Khalid al-Falih, Saudi Arabia’s new oil minister, said on 2 June, during his first appearance as minister at the OPEC meeting. He stated that OPEC plays an important role as a responder to sudden production disruptions. Furthermore, OPEC strives towards a balanced price, allowing for investments in production in order to meet increasing demand for oil. The outcome of the meeting was disappointing: there was no agreement on a shared production ceiling, which meant OPEC’s strategy remains unchanged. OPEC’s President did stress the importance of a close collaboration between OPEC and non-OPEC countries in order to guarantee stability on the market. At that moment it was quite successful: the oil price barely responded to the meeting’s outcome.
Oil prices forecast raised
ABN AMRO has raised its end-of-year oil price forecast from 55 USD/bbl to 65 USD/bbl. The adjustment was based on various arguments. Our forecast for the average oil price of 2016 remains unchanged at USD 50/bbl.
Earlier we mentioned that the recent strong increase in the price of oil can be attributed mostly to speculation and temporary production disruptions. But the real structural impact of global CAPEX reductions, as is the case for almost all national and international oil companies, has yet to be seen. If the low oil price leads to lower production in non-OPEC countries, it will lead to a higher oil price instead. The initial effects of the low oil price are now starting to become visible. By now, the lack of investments is resulting in lower oil production in several countries, such as Mexico, the United States and China. But oil production is also under pressure in OPEC countries such as Nigeria and Venezuela. While the oil price recovered somewhat in the past few months, we expect that oil production will be under additional pressure, or will stabilize at current levels in the best case.
In the recent past, one reason not to expect any price hikes was the expected growth of Iran’s oil production. But by now, Iran has shown itself capable to increase its oil production much quicker than expected, reaching pre-sanctions levels. The expectation is that exports will soon also return to pre-sanctions levels. And while Iran has indicated it would like to increase production by 10%, just as Saudi Arabia did in the past few years, the question remains as to what extent Iran will be successful in doing so. Although there is sufficient oil in the ground, the lack of investments in the oil infrastructure for many years now cannot be overcome in mere months. It may therefore prove to be difficult to significantly increase oil production on a structural basis.
The so-called quick wins are already put into operation in other regions as well. In other words, additional production has already been sourced from oil fields that were relatively easy to access and had infrastructure in place. That means that in order to achieve additional growth in oil production, significant investments in the sector and infrastructure will have to be made. However, many investors are more reserved after the strong price decline last year. For now, they believe the risks to be too large, and first want to see how sustainable the recent price increase will be. It therefore seems unlikely there will be a strong growth in production in the short run.
What is striking is that OPEC was able to significantly increase production in the past few years, which would have led to unrest not too long ago. After all, additional production lowers global reserves. And it seems that, at this moment, this isn’t something to be worried about. This is partly justified. It turns out that the world has sufficient oil reserves in the ground. Especially considering the technological developments which, as a result of the low oil price, experienced an enormous boost, and allow for the extraction of oil against lower costs and higher efficiency than assumed earlier. But, one should note the fact that most of these projects have a long time-to-market. Not a typical feature of spare capacity. Still, it seems there is upward potential in the production levels of Saudi Arabia. And, perhaps even more important: if there is a calamity resulting in an imbalanced market, the oil price will shoot up, rendering US shale oil more attractive. The lead times of these kind of projects are considerably shorter than the traditional oil extraction projects. As a result, it may even be considered part of the global spare capacity in oil production.
The US dollar is currently strong, but still at the low end of our forecasted bandwidth of EUR/USD 1.10-1.20. Uncertainty surrounding the Brexit referendum provided some support to safe havens, like the US dollar. We do not expect rate hikes in the US this year. This should be supportive for the US economy, and as such we do not expect the dollar to appreciate further. Therefore the dollar should not prove to be an obstacle for higher oil prices.
And finally, the global demand for oil will keep growing strongly. The demand for oil in 2016 is expected to grow with approximately 1.3 million barrels per day (mb/d). For the most part, this growth arises from emerging countries in Asia: China and India. The demand for oil is expected to grow faster than supply, leading to a better match between demand and supply, resulting in higher oil prices. Naturally, higher oil prices could lead to more investments in the oil sector and more drill rigs, especially in the U.S. But it could take 12 to 18 months before the effect would become visible in terms of an increase of global oil production, perhaps even longer. The question is also whether oil producers are able to obtain funds as easily as they did during the shale oil revolution. Meanwhile, oil storage capacity is at its max, and more production would be hard to store. Overall, excess supply of oil in the market, which has only started to grow since the start of 2014, will disappear. The balance may even tilt towards global shortages. The main risk associated with oil prices is currently tied to a lack of investments, and therefore in a higher oil price.
After having reviewed the situation, we have decided to adjust our oil price forecast. Our forecast for year-end 2016 has been raised from 55 USD/bbl to 65 USD/bbl. However, our forecast for the average oil price of 2016 remains unchanged at USD 50/bbl. With oil prices trading around USD 50/bbl, speculation for a stabilisation or even increase in US crude production could trigger some downward pressure on oil prices in the near term. We expect the continuation of the oil price rally to materialise in the fourth quarter of 2016. Please see table 1 for the other price forecasts.