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Oil oversupply seen till end of 2016

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Oil prices, already close to six-year lows, are deemed to stay low till at least late next year after Organization of the Petroleum Exporting Countries (Opec) not only decided to keep to current production levels but also abandoned any official production target.

Singapore

OIL prices, already close to six-year lows, are deemed to stay low till at least late next year after Organization of the Petroleum Exporting Countries (Opec) not only decided to keep to current production levels but also abandoned any official production target.

The stand by Opec confirms the shift to a new world order in oil - one in which the risk of price spikes and volatility is greater than before, say analysts.

The cartel, after a meeting in Vienna last Friday, retained its one-year-old policy of not constraining output despite an oversupplied market, an outcome that had been expected given Saudi Arabia's signals in the days before. Opec's decision to do so in its meeting a year ago had shocked the market, sending oil prices tumbling 60 per cent from a peak in June last year.

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Brent, a global crude oil benchmark, was trading at US$42.73 a barrel at 7.30pm Singapore time on Monday, while US West Texas Intermediate traded at US$39.42.

What surprised the market this time was Opec's lack of any mention of a production ceiling - something it has indicated almost without interruption since 1982.

This left observers "substantially perplexed", said OCBC economist Barnabas Gan. "This is a clear message from Opec that its strategy to keep market share is working," he said. "Opec is sending an ultimatum to its competitors: the fall in oil production should come from them."

The sudden omission should not be surprising as the cartel - whose members together produce more than one third of world oil - has not adhered to its target of 30 million barrels a day for the last 18 months, Mr Gan added. "The removal of the ceiling thus is in fact the most logical move given the inefficacy of it."

Opec now produces about 32 million barrels a day. This is set to rise as Iran returns to the oil market and as the cartel includes Indonesia - whose return to the organisation was confirmed on Friday - in its count.

Iran, Saudi's arch-rival, is eager to reclaim the market share it lost under sanctions imposed in late 2011, and has said it plans to increase exports by 1 million barrels a day. Many, however, regard this as an overly optimistic projection.

Indonesia's production capacity is estimated at 800,000 barrels a day.

In its press release, Opec also noted that global economic growth is forecast to expand by 3.4 per cent next year, with global oil demand expected to expand by 1.3 million barrels a day and non-Opec supply to contract by 2016.

Opec projected in a November report that the current market surplus of almost 2 million barrels a day would narrow to some 560,000 barrels next year, if it pumps at October's rate.

As Opec continues to produce at will, the stage is set for higher oil production and greater pressure on oil prices in the next few months, said Victor Shum, vice-president at energy consultancy IHS Inc. US shale oil producers, whose production is already dropping after reaching a peak in April this year, would feel the pressure the most, he added. In his view, an expected rise in interest rates after the US Federal Reserve meets on Dec 15-16 would also further hurt these producers, many of whom are heavily geared.

The fall in US production would help to compensate for the expected increase in Iranian oil, said Mr Shum.

"The end-effect of this is quite likely that in the second half of 2016 we are going to see a more rebalanced oil market," he said, though cautioning at the same time that the net impact of a US interest rate hike is uncertain as a stronger US dollar could also mute demand from emerging countries for oil which is dollar-denominated.

Goldman Sachs analysts - pointing to the current high oil surplus, resilient non-Opec supply, and "slightly weaker yet still robust" demand growth - also expect the global oil market to rebalance in the fourth quarter of next year. "We reiterate our view that prices need to remain 'lower for even longer' for fundamentals to warrant the price increase we forecast late next year," the bank said in a note last Friday.

Capital Economics, a consultancy, and French bank Societe Generale are expecting Brent to rebound to US$60 at end 2016.

More significantly, the latest decision by Opec is seen as affirming the widely held belief that a new world order in oil has come.

With Opec neither setting prices nor output quotas, it will no longer matter whether a producer is a member of Opec, said IHS senior director Bhushan Bahree in a report last Thursday; the discipline of price and cost will be the key for all oil producers.

Because of this, planned investment in deepwater, oil sands and other relatively high-cost projects have either been cancelled or put on hold, and the industry will spend nearly US$1.5 trillion less than it had planned to from 2015 to 2019, according to Mr Bahree, who is based in Washington.

As spare capacity in the oil market - mainly held by Saudi Arabia - dwindles, however, any disruption of the market would have a stronger impact on oil prices. Said Mr Bahree: "The risk of price spikes and volatility is greater than before."

READ MORE: Opec decision pulls oil prices close to 2015 lows

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