After woeful outing last year, oil prices rose after the Organisation of Petroleum Exporting Countries (OPEC) agreed to production cuts towards the end of the year. Prices however fell again early this year over concerns about oversupply and high inventories.
A recent rebound seems to have renewed hope in investors that recovery is finally underway after three years of gluts, although a price boom seems unlikely as the market shows that at least until OPEC’s supply deal expires, producers will take advantage of any rallies.
Oil price gained about 20 percent in the last two months to rise above $52 a barrel, posting ‘higher highs and higher lows,’ which would suggest this rally is more robust than the recoveries seen in March and May this year.
“It has been a good rally since June but now crude oil has to prove that it can break its downtrend channel,” said, Olivier Jacob, a petroleum analyst.
Investors have been worried doubt about the ability of the OPEC and its partners to stick with a pledge to restrict output by 1.8 million barrels per day until March 2018, especially given resurgent output from Libya and Nigeria, which are exempted.
With the recent rebound in price, Saudi Arabia’s Oil Minister Khalid al-Falih told a London-based Arab daily that the oil market has started showing signs that it is headed in the right direction, and current expectations point to the market returning to balance in the fourth quarter this year. “In my opinion, market fundamentals are going in the right direction, but in light of the large surplus in stockpiles over the past years, the cut needs time to take effect,” he noted.
“Current expectations indicate the market will rebalance in the fourth quarter of this year taking into account an increase in shale oil production.” On the recent oil price drops, al-Falih said “It was not our goal when launching this initiative in Algeria to reach a specific price. Prices are determined by markets driven by many variables beyond the control of producing countries and unpredictable.”
Oil prices have not had a smooth ride over the past few months. As a result, investors find it challenging to predict anything. It all started at the end of 2016, when members of the OPEC agreed to the first cut in oil production in eight years after months of haggling.
The cartel also reached a deal with Russia and other non-OPEC states to curb output. This policy was intended to reverse a two-year slump in global oil prices that has dramatically eroded their earnings. Generally, investors were happy with this upward shift in the oil price, especially equity holders of oil companies and oil-producing markets.
In response, oil prices increased with Brent crude (an important benchmark) rising above $55 a barrel for the first time in more than a year, contrasting sharply with the start of 2016 when it had fallen below $30.
To the disappointment of investors holding oil-related investment assets, prices dipped lower again early in the year on renewed fears of oversupply and news of an increase in the amount of oil in storage, erasing almost all the gains made since OPEC announced its cuts.
Experts said that oil stockpiles largely explained why crude prices suddenly dropped, with West Texas Intermediate (another benchmark, focused on US oil production) falling back below $50 a barrel in the first half of March.
When OPEC agreed to a production cut last year, investors were encouraged to buy oil, pushing prices higher. US shale oil and gas producers then increased production to take advantage of higher prices. Meanwhile, in the months before cutting output, OPEC had increased production, which is now being delivered into US ports and put into storage.
The level of inventories is linked closely to the pricing of futures contracts in oil. A futures contract is an agreement to buy an asset at some point in the future at a pre-agreed price. These agreements are an asset class in themselves, and can rise and fall in value as the price of the underlying asset changes.
OPEC had aimed to rebalance supply and demand by the middle of 2017 to lower the prices of long-term oil futures relative to the short-term. This was intended to encourage markets to buy oil and use it rather than store it. This strategy worked for a while, but since the US released its inventory data, the opposite has happened, and long-term futures are currently worth more than the short-term. This means that it’s more worthwhile for investors to buy oil and store it than use it for industry and thus reduce inventories. Experts said that oil prices are likely to continue to fall if inventory levels remain high, which may encourage OPEC to extend its output cuts.
Available indices showed that OPEC is not ruling out extending supply cuts. Together with stabilizing U.S. inventories, Brent crude futures rose to a two-month high of $52.68 on July 28, rounding off its strongest week so far since this year.
Bullish investors are supporting the market because they believe the long-awaited rebalancing is taking place in the oil market. They are basing on the rally on Saudi Arabia’s decision to limit oil exports to 6.6 million barrels per day (bpd) in August, and the four weeks of slowdown in U.S. oil stocks.
Recent data show that the rebalancing of the oil market is speeding up and if the slowdown trends of U.S stocks are sustained, stockpiles will normalize by early 2018.
According to Goldman Sachs, an Investment bank, while OPEC’s production path remains uncertain, recent fundamental oil data have come in even better than expected.
“If sustained, these trends would help achieve the normalization in inventories by early next year,” added Sachs.
Nigeria’s production challenges
Penultimate week, two crucial developments took place, which will likely affect Nigeria’s crude oil production and the 2017 budget. The first is the acceptance of the country’s proposal to cap its oil production to 1.8 million barrels a day and a reported resumption of oil militancy in the oil-rich Niger Delta. Both developments, which are made worse by the unstable prices of crude oil in the international market, could delay Nigeria’s reported gradual exit from economic recession that it officially slumped into last year.
The OPEC and non-OPEC producers, led by the Russian Federation, approved the decision of the Nigerian government to cap its oil production at a sustainable volume of 1.8 mbd, having pressed Nigeria and Libya, which got an initial exemption from a production cut agreement to stabilize prices, to consider coming into the agreement.
At the Joint OPEC and Non-OPEC Ministerial Monitoring Committee (JMMC) meeting in July in St. Petersburg, Russia, OPEC and its ally reviewed the June 2017 report on its freeze agreement. JMMC also listened to the presentations made by the representatives of Libya and Nigeria on their production recovery plans, prospects and challenges.
The oil producer’s groups, which agreed to cut oil output by a combined 1.8mbd starting from January 2017 until the end of March 2018, then accepted Nigeria’s proposal to cap its output on 1.8mbd. This was amid difficulties with Nigeria’s recovery of its production from destruction caused by internal strife in the Niger Delta.
In a communiqué issued at the end of the St. Petersburg meeting, the JMMC said it welcomed Nigeria’s flexibility in this regard, “which despite its commitment to recover its pre-crisis production level, voluntarily agreed to implement similar OPEC production adjustments as soon as its recovery reaches a sustainable production volume of 1.8 million barrels per day.
In his remarks at the opening of the JMMC, OPEC Secretary General, Mohammed Barkindo, who was once head of Nigeria’s national oil corporation, NNPC, assured other producers that Nigeria had no intention of going beyond its oil production target of 1.8mbd until the end of March 2018.
But just as Nigeria’s output cap proposal was approved at the St. Petersburg meeting, the country reported a fresh break on one of its crude lines – the 180,000 barrels a day Trans-Niger Pipeline. The attack upset its recovery from low production levels.
Already, the country had benchmarked in its 2017 budget a daily production of 2.2mbd, but the attack on the TNP located in the western Niger Delta in the early hours of Monday resulted in the shut in of 150,000bpd.
Minister of State for Petroleum Resources, Ibe Kachikwu, however, stated that the country’s budget would not be seriously affected by the recent developments. Kachikwu said in Abuja that the production cap was not yet effective, and would not be until the country was comfortably placed to report to the groups a consistent production pattern in line with the cap.
He explained that out of the 2.2mbpd production volume in the budget, about 450,000 barrels were purely ‘condensate’, leaving the balance as crude oil alone, thus indicating that the country was still in line.
According to the minister, “First of all the 1.8mbd has not gone into effect. I am meant to report back to them within the nine months’ timeframe we were given exemption to confirm that we have stabilized production and stabilization of production does not mean that we produce 1.8mb in one day then there is stabilization.
“There is going to be a month-to-month analysis where we will get comfort that all things that prevented us from stabilizing our production have ebbed and we can consistently produce above 1.8mbd.
Experts however does not believe the capping of Nigeria’s output is in the best interest of the country, as the economy is still on its knees.
A petroleum analyst, Bala Zakka, said that the Federal Government must look for ways to assuage the harsh economic realities that would follow any likely cut in crude output by Nigeria.
He noted that Nigerians were already suffering the negative effect of an economy that is in recession and it would be too much to bear if no concrete step was taken to cushion the effect of a reduction in Nigeria’s crude oil production.
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