Volatility in the global oil market

The attacks on Aramco’s Abqaiq-Khurais facilities in Saudi Arabia on September 14 saw the United States (US) offering to tap into its emergency reserves to offset disruptions in oil markets. The International Energy Agency (IEA) also said that markets are well-supplied. The Organization of the Petroleum Exporting Countries (OPEC)+ group could possibly review its quota cuts that were installed in December 2018, should there be a need. Despite tensions in the Gulf, oil prices have remained within the $60-$70 range.

The most important factor providing an upper band to prices and acting as a middle-term balancer is the US shale revolution. In the pre-shale era, supply was easier to predict — production was concentrated in the hands of a few powerful OPEC countries, and some scattered mega projects outside the cartel. However, shale has upended this equation and introduced new global pricing dynamics. Currently, the US is the most prolific oil producer globally. In less than eight years, US oil production climbed from under six million barrels per day (mbpd) to more than 12 mbpd. However, despite its prolific nature, the supply of American shale is becoming erratic.

The three key shale-producing basins in the US — Permian, Eagle Ford and Bakken — have seen reduced or flattened growth recently. The Wall Street Journal reported that, this year, more than a dozen companies are reducing spending. The recent plunge in natural gas prices is stifling capital spending. It is unclear if the current decline is permanent or reversible. Given the elastic characteristics of shale, American production is highly sensitive to changes in drilling activities, which has major implications for global oil balances. No source has ever seen such sharp decline in the history of oil markets as shale. Shale 3.0 will have to chart a narrative of more measured growth. Though it is too early to write OPEC+’s obituary, the cartel is struggling with challenges, which are not in-house anymore. There have been 10 non-OPEC members joining the production-cut pact, while Qatar left the group early this year, ostensibly to focus on natural gas production. The new Saudi energy minister Adbulaziz bin Salman, has said that OPEC may discuss deeper cuts in December, although this will now depend on how fast Aramco recuperates from the attacks.

But the Russia-OPEC alliance link is becoming tenuous. Russia, Iraq and Nigeria have been playing truant in ensuring compliance. Saudi Arabia may not be able to afford deeper cuts — bin Salman has to put a floor under prices, especially with the looming initial public offering (IPO) of Saudi Aramco. The attacks have also exposed Aramco’s vulnerabilities, which does not augur well for its IPO. Added to unpredictable supply factors is the fact that global demand rests on too many fluctuating variables. OPEC has cut its global forecast for 2019 due to the ongoing trade disputes. The IEA has downwardly revised demand estimates by 100,000 bpd for 2019 and 50,000 bpd for 2020. Giovanni Serio, Vitol’s global research head, recently said that there was a difference of 20 mbpd in IEA’s 2018 outlook between its high-demand and low-demand scenario for where consumption would be in a decade. This range was only six mbpd in its 10-year outlook in 2010. With the removal of the hawkish John Bolton as the US national security adviser, there are signs of possible rapprochement between US and China and US and Iran. The White House is considering an interim trade deal with Beijing and has decided to push back additional tariffs on $250 billion worth of goods that would have triggered on October 1, in exchange for China dropping some of its retaliatory tariffs. Investors are also counting on the Federal Reserve making a second cut, after the one in June, to prop up demand.

With Tehran, Trump has indicated easing of sanctions that were imposed in June. Though the sabre-rattling may tone down a bit, the list of sticking points with the Chinese is too long, and the list too complex with the Iranians, to see a resolution in the immediate future. Trump, due for re-election next year, faces a tricky situation. He needs to ease out trade issues that have started hurting his voter base, while maintaining his tough reputation of arm-twisting countries to engender favourable deals for the US. He may tread a middle path of keeping tensions simmering while negotiating some priority sectors for the Americans. Geopolitical outcomes, in recent times, have rarely been so personality-driven — JP Morgan created the ‘volfefe index” to analyse the effect of Trump’s tweets on volatility in interest rates. Pinning the loci of oil prices has become trickier in ways that are unprecedented. For agencies, making any meaningful forecast for the medium, or even the short-term, has become a rather slippery task, leave alone factoring-in emergencies like the recent Aramco attacks.