Understanding the key dynamics driving commodity prices in an industry that will continue to fuel the world’s power and transportation needs for decades to come can help us navigate potential opportunities in the energy market with greater clarity and confidence. In this perspective, we look at one of the central features in the world’s oil supply & demand balances: the geopolitics of OPEC.
In monitoring the major fundamental drivers of the global oil market – supply, demand and inventories – we can’t understate the collective impact that OPEC has on global oil supply. Since late 2016, the group has cooperated with select other producers such as Russia to implement production caps that have been instrumental in rebalancing the oil market. Together, these producers and OPEC are responsible for more than 40% of global oil supply, so energy market participants continuously monitor the group’s actions and intentions.
In mid-February, OPEC concluded that the multiyear oil inventory glut has been eradicated more rapidly than expected, and that the global oil market will be in balance in the second or third quarter of this year.1 While recent reports suggest some differences in OPEC members’ opinions regarding the optimal price for oil,2 the cartel still appears poised to exercise continued restraint in support of a balanced oil market.
Three factors seem to suggest this group really means business when it comes to balancing the oil market:
- Unlike past efforts, the consortium has demonstrated unprecedented commitment to the production caps implemented in 2016, a signal members are willing to tighten their belts to rationalize supply, convincingly and without delay. For January, compliance with the agreed-upon cuts was 133%.1 This compares quite favorably with historical OPEC compliance rates of around 60%.3
- The participation of Russia along with other smaller producers that are not technically members of OPEC expands upon OPEC’s historical market-balancing role. This gives the group greater ability to influence markets, especially if these nonmembers agree to continue cuts beyond 2018.
- While initial statements from OPEC focused on restoring the oil market to historical average inventory levels, there is now discussion of taking things even further, to target an even lower inventory level and thus a tighter physical oil market. This is an indication that these producers are willing to continue enduring some short-term discomfort in order to greatly reduce the odds of another supply glut.
In addition to healthier state budgets for participating countries, most of whom rely heavily on oil revenues for government funding, there is strong motivation on the part of the group’s leader – Saudi Arabia – to put a floor under oil prices and to stabilize the oil market. This motivation stems from the plans that have been hatched by the young Crown Prince of Saudi Arabia, Mohammad bin Salman. The Crown Prince’s agenda is a broad-sweeping and progressive program dubbed “Vision 2030.” The agenda calls for significant diversification of the Kingdom’s economy – away from its historical near-exclusive reliance on the petroleum business – to include tourism, health care and education, among other pursuits. The check that will finance all of this has yet to be written: listing a portion of the Kingdom’s national oil company, Saudi Aramco, in an initial public offering that could value the enterprise at as much as $2T. Clearly, a relatively strong and reasonably stable oil price environment would be far more supportive for this transaction than a volatile and/or much lower price environment.
THE BOTTOM LINE
The oil market has witnessed a dramatic multiyear rebalancing and is on much firmer footing now than it has been in the last five years. Assuming that this group of producers continues to hold the line on output, the market should remain stable, with relatively tight balances. While nothing is certain in oil markets or geopolitics, there are several indications of meaningful support for continued caps on production from this critical mass of producers. Their continued restraint could set up for lower oil-price volatility and support prices in a healthy range, making for an attractive environment for energy companies, including both upstream producers and owners of domestic infrastructure assets. Importantly, the tighter overall supply-demand balance creates room for growth in U.S. oil production, which is set to exceed historical records this year. Domestic shale plays are a low-cost source of supply that can readily fill the gap created by international producers’ restraint.
1 Bloomberg, “OPEC, Russia Said to See Oil Glut Dissipating at a Faster Rate,” http://bit.ly/2tM7ter.
2 WSJ, “OPEC Price Fight Weighs on Oil,” http://on.wsj.com/2HtG9mW.
3 Oilprice.com, “IEA Tracks 40 Percent Compliance Rate for Non-OPEC Deal Participants,” http://bit.ly/2Il3J6F.
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