THE price of oil has been on a roller-coaster ride over the past few years, falling from its 2014 peak before making a steady recovery earlier this year. Brent Crude, the major benchmark price for oil purchases worldwide, rose more than 20% in the first half of 2018, before hitting a four-year high of US$86.07 a barrel in early October.
Owing to the US sanctions on Iran, it saw the “Opec+” countries step up their oil production by around 1.2 million barrel per day (bpd) between May and October 2018.
There is a possibility for the increased oil production in October of 1.2 million bpd to be further revised upwards to around 1.4 million – 1.5 million bpd remains high.
The higher production was due to the growing fears that renewed US sanctions on Iranian oil exports could reduce global oil production by more than a million barrels a day. The risk of oil price surging as a result of the sanction has raised alarm bells with expectations that the oil prices could reach US$100 a barrel.
Following the recent highs on Oct 3, 2018, global crude oil prices that is WTI and Brent crude fell more than US$20 per barrel. The market has turned bearish due to a string of reasons.
The US sanctions against Iran could be the primary factor. The Trump administration has granted temporary sanction waivers to eight countries purchasing crude from the country easing the impact of full sanctions. Such an action by the United States may have removed the earlier concern that about one or two million barrels of oil would come off the market.
Besides, potential economic global growth is envisaged to moderate in 2019 due to the ongoing trade war between the United States and China that is causing some knock-on effect on global trade. Besides, the aggressive interest rate hike instituted by the US Federal Reserve and stronger US dollar had raised concern on a potential emerging market debt crisis, especially with the risk rising on those countries with twin deficits i.e. fiscal and current account added with huge US dollar denominated debts.
All these emerged suggests the US oil production increased by 1.0 million bpd over the same period from May-October
Important for Opec to set baseline plan
The recent oil price correction has caused a rout. The sharp drop in oil price resembled the scenario during the 2008 Global Financial Crisis. It also reflected the aftermath of the November 2015 Organisation of the Petroleum Exporting Countries (Opec) meeting, when the group decided not to act in the face of an oversupplied market.
Meanwhile, it appears that Opec and other producers could potentially agree to reduce output when they meet in Vienna on Dec 6 supported by the story line that the oil market will be oversupplied in 2019.
Crude oil prices have tumbled more than 20% in just eight weeks, and most Opec members fail to stand a chance of balancing their budgets at current price levels.
But this time around, we are dealing with a very different set of challenges. For a start, we have the US president who is fiercely opposed to price-boosting production cuts. Opec and its alliance may need to cut one million to 1.4 million barrels a day to address the current oversupply. It can be a tall order for Opec to announce cuts on such scale.
A key reason being Saudi is badly hurt by the revelations that agents of the kingdom murdered Washington Post columnist and US resident Jamal Khashoggi.
President Donald Trump is standing by his allies in Riyadh, but he’s made it clear that he wants the Saudis to keep a lid on oil prices in return for his loyalty.
Hence, there are possibilities for Opec to announce that its members will maintain the quotas they announced in 2016, which would mean that those who have surpassed the level may have to reduce their production.
Saudi Arabia, for example, is believed to be exceeding its 2016 quota by about one million bpd this month. Iraq exceeded its quota by about 300,000 bpd in October, while the United Arab Emirates topped its output cap by nearly as much.
But it remains unclear if the Saudi will lower its output alone. Looking at Iraq, they have in the past resisted large cuts. They are unable to sacrifice oil revenues after withstanding 15 years of war and unrest.
Similar scenario is with other Opec members like Libya and Nigeria. Both were exempt from the original deal in 2016 due to ongoing internal conflicts that curtailed their oil supplies.
They have yet to commit to cutting output, even though production has surged in Libya and ticked higher in Nigeria.
Meanwhile, Russia seems to have indicated production cuts. But one remains sceptical of Russia’s commitment given that it can balance its budget with Brent crude around current levels. Any cut by the Russians would see negotiation as they are unlikely to be involved in any kind of tangible way. At best, its commitment could end up being a verbal endorsement.
What is really important in this Opec meeting is the baseline that they plan to set for production cuts.
If Opec sets the baseline where the cuts are based on the most recent month, its impact will be less meaningful compared with the previous month when it pumped less oil. While such details remain unclear at the moment, chances are there are still no agreement on the baseline. So, the base could be that there will be a cut that could end up being underwhelming.
With the possibilities of the coming Opec meeting to conclude with an official statement that leaves the market hanging with just how many barrels Opec intends to take off the market, there is a strong possibility for the oil market to fall apart.
If the Opec meeting fails and becomes an ambiguity, one can foresee the oil traders expressing their disappointment by pushing the price down as low as US$40 per barrel. Already, prices have fallen by 35% over the last eight weeks.
Meanwhile, the equilibrium range for oil price should be between US$60 and US$70 per barrel after taking into consideration the supply-demand outlook for 2019 that could see the market build inventory around one million bpd should there be no supply disruptions. So 2019 average base case for Brent is around US$65-US$69 per barrel.
Anthony Dass is chief economist of AmBank group and adjunct professor, faculty of economics, UNE, Sydney, Australia.