Energy Monitor May – All hands to the pump

by: Hans van Cleef

  • Upcoming OPEC meeting: devilish dilemma calls for action
  • Oil price outlook unchanged, but with reduced conviction
  • Gas price volatility cools in run-up to summer season
110517-Energy-Monitor-May.pdf (238 KB)

OPEC in a tight spot

Coming up on 25 May is the next official half-yearly OPEC meeting in Vienna, Austria. At this meeting, the oil ministers must decide on the oil output level for the coming months. Last time, they agreed to reduce the production ceiling by 1.2 million barrels per day (mb/d). Several non-OPEC producers also cut production by 0.6 mb/d. The intention was to bring oil supply more into line with global demand. OPEC hoped that less oversupply would keep oil prices on an upward trajectory. A higher oil price would not only be welcome news for the oil producers, but also for the governments whose fiscal policies are based on an oil price that is significantly higher than the current spot prices.

But, as the above chart shows, barring the uplift in the fourth quarter in anticipation of the imminent OPEC agreement, the price received no extra upward impulse. As a result, the lower production ceiling stabilised the oil price at a higher level than at the start of 2016. An additional price rise failed to materialise because the US oil production machine regained momentum, thus cancelling out the OPEC production cut. The upshot is that the OPEC production agreement has so far merely brought about a shift in market share. This confronts OPEC with a devilish dilemma: support the oil price or maintain market share.

From two to three scenarios

The signals from the OPEC members – and particularly the oil minister of Saudi Arabia – and non-OPEC members taking part in the production ceiling are growing louder now that the OPEC meeting is more on the radar. The verbal intervention strategy worked well last year. To prevent the impact of the agreement from ebbing away, OPEC – alongside various non-OPEC countries (mainly Russia) – felt forced to genuinely cut production in January. Concrete action was necessary to back up the words. The initial expectation was that oil producers would again have to choose between two scenarios: extend the production ceiling or not. But even continuation of the production ceiling need not necessarily boost the oil price. So a third scenario is needed. Guided by the comments of various oil ministers, the market is once again counting on an extension of the lower production ceiling. This means that the coalition of oil-producing countries must choose one of the following three scenarios at the end of this month:

  1. The agreement is extended in line with market expectations. If the extension is for six months – and preferably longer – supply and demand will progressively converge in the course of 2017/2018. The problem is that this scenario has already been priced in. In this case, the oil price will not rise much further than USD 50/bbl in the coming months, which is below what most oil producers would like to see. Nevertheless, this is the most probable scenario in our view.
  2. Another alternative is to drive the oil price up to a higher level. To achieve this, the OPEC/non-OPEC coalition must surprise the market with a lower-than-expected production ceiling. This could wrong-foot speculators, leading to expectations of evaporating oversupply being factored into the price. This option is possible as OPEC can cut output faster than US oil producers can ramp it up. That said, a dampening effect could come from the high inventories of crude oil and processed products. To achieve a permanently higher oil price, inventories must also be brought down to a structurally lower level.
  3. The final scenario involves abandoning the production ceiling in order to prevent a further shift of market share. Judging by the noises coming from OPEC and its mission to stabilise the price, this scenario does not seem probable. A cautionary note is in order, however: this scenario did not seem very likely at the end of 2014 either, but did become reality as OPEC attempted to squeeze US shale oil producers out of the market. So this option cannot be entirely ruled out.

Oil price outlook unchanged, but…

We foresee a moderate recovery of the oil price. This is based on the view that the market is slowly but surely gravitating towards equilibrium, which would justify a slightly higher oil price (see Table 1). The uncertainty surrounding the production agreement, however, is also affecting oil price expectations. We think it is too early to reduce our outlook given that, in scenario one, and definitely in scenario two, we feel that a further rise in oil prices remains probable in the second half of this year. But due to the increased probability of scenario three – renewed focus on the protection of OPEC market share – our conviction has, in fact, become a little less firm. For now, we maintain our expectations while continuing to watch the market closely to check whether these expectations still correspond with our thoughts.

Gas prices stabilise as summer season draws near

Since peaking in early February, the price of Title Transfer Facility natural gas (TTF) has dropped. The strong seasonal demand for heating gas has fallen and in the past weeks the price of this Dutch virtual marketplace for gas has even remained stable in a narrow bandwidth of roughly EUR 15-16.50/MWh. This time, the announcement that, effective from October, Dutch Economics Minister Kamp had ordered a further reduction in the production of gas from the Groningenveld gas field did not trigger a price spike. This latest production cut follows the recommendation of the SSM (State Supervision of Mines) and is intended to prevent further earthquakes in the gas extraction area. Production will be cut by 10%: from 24 billion cubic metres to 21.6 billion cubic metres per year.

The price of Henry Hub natural gas (US) has also reached calmer waters and is moving in a narrow bandwidth of USD 3-3.35/mmBtu. The recovery of the oil and gas sector in the US has not yet boosted the supply of natural gas sufficiently to have a negative price impact. Nevertheless, the number of specific gas drilling rigs has more than doubled to 173 since September 2016. We still expect increased supply, combined with reduced demand, to push the Henry Hub gas price lower in the coming months.