Small hopes for Big Oil meeting

Singapore

AT the meeting of the Organization of Petroleum Exporting Countries (Opec) in Vienna on Thursday, tensions will be high behind closed doors, but on the other side of them, expectations will be low.

The cartel's meeting might be a last-ditch attempt to halt the slide of oil prices by cutting production, but the market has already begun to count the cost of cheaper oil. While net importer countries stand to gain, the oil sector is in for some hurt. (see infographics)

Since peaking in June, crude oil prices have tumbled by about a third to a four-year low where they languished at US$74.09 and US$78.33 per barrel for West Texas Intermediate crude and Brent crude, respectively, by Tuesday.

The prognosis for the Opec meeting is bleak. Leading up to it, a meeting on Tuesday among Saudi Arabia, Venezuela, Russia and Mexico - the latter two are non-Opec producers - failed to result in an agreement to cut output.

Even within Opec, consensus is difficult because its members have wildly differing cost structures and objectives. Analysts estimate that member countries such as Iran, Algeria, Nigeria and Ecuador need a price of US$115 per barrel to balance their budgets and keep social spending up, while Kuwait and Qatar need only US$75 per barrel. Saudi Arabia, the group's largest producer, also looks disinclined to cut production as it has the scale to withstand lower prices.

Opec might account for a third of global oil production but the problems confronting the commodity dwarf the cartel's influence. US shale oil has pumped up supply even as demand has fallen, thanks to an embattled European economy and a slowdown in China.

In the face of these factors, Opec has the relatively blunt tool of production control, which might not have the intended effect on prices, or even production. The cartel is largely seen to have three options - maintain the existing quota of 30 million barrels a day, cut it by a token sum of about 500,000 barrels a day, or make a larger, more significant cut. Even sticking to the current quota will mean making cuts because the cartel's daily production tends to bust the limit by several hundred thousand barrels.

Keeping to the current quota - the likeliest outcome - might help halt the price slide at about US$75 a barrel and eventually lift it to US$80 a barrel during winter, an OCBC Bank report last week reckoned. A token cut of half a million barrels might lift prices to US$80 immediately, it added.

A substantial cut, however, could backfire. "While this may inject an initial substantial oil price surge, depending on the quota cut, we believe that the increase in oil price may be short-lived, given the US oil industry's ability to replace the lost production by Opec," the OCBC Bank report said.

The meeting's outcome notwithstanding, the market is braced for lower oil prices in the coming year. 2014 started out with oil above US$90 a barrel but this price level is viewed as a supremely optimistic one going forward. "Prices could find the US$70- US$90 equilibrium level in the years ahead," a Citi Research report noted this month.

As oil prices decline, they will tug down overall inflation which is already low and a source of worry for some central banks with an eye on deflationary pressures. In Asia, a Barclays Emerging Markets Research report last month estimated that every US$10 drop in oil prices could shave an average of 40 basis points from its headline inflation forecasts.

Already, low oil prices have helped to ease Singapore's October headline inflation to 0.1 per cent - the lowest the country has seen since December 2009. During the month, prices of oil-related items fell 2.1 per cent.

In Singapore's case, this declining rate of inflation is unlikely to be cause for panic. "We note that the sources of disinflation have been relatively benign thus far. For instance, lower oil prices are unlikely to be viewed by the central bank as a negative, given its potential as a supply-side boost to consumer and also global demand," a Credit Suisse report said this week.

Net importers of oil have the most reason to cheer lower prices, which tend to boost current account balances and gross domestic product (GDP) growth.

A US$10 a barrel drop in crude oil prices could lead to an average increase of 0.08 per cent for GDP growth through Q4 2018, according to the Citi Research report which estimated that prices could range from US$70 to US$90 in the coming years.

Even Singapore with its large current account surplus might see some upside from lower oil prices. For every US$10 a barrel decline, the country's current account balance could improve by 0.9 per cent, estimates the Barclays Emerging Markets Research report. Compared to a base scenario of US$110 a barrel, this works out to savings of US$8.6 billion if oil averages US$80 next year.

For the oil companies on the other side of the equation, the outlook is decidedly gloomier. BP's share price has shed more than 20 per cent since July, while Chevron has slumped about 13 per cent.

Other parts of the supply chain have not been spared. Rig builder Keppel Corporation's counter has slipped 17 per cent since the start of 2014, while Ezra Holdings, with its exposure to the deepwater market, has plunged 44 per cent over the same period.

If oil prices continue downwards, the screws on the sector will only tighten. "If the oil price falls, IOCs (international oil companies) must adjust their cash flow in line with the falling selling prices," an ABN Amro report warned this month. "They will initially put a brake on this by reining in their expenditures . . . They will also seek to take advantage of any scope to negotiate lower prices with subcontractors. New contracts with subcontractors are already a quarter cheaper than one year ago."

For the industry, plenty will ride on Thursday's Opec meeting. "Sentiment in the oil and gas sector will remain fragile till we see stability in oil prices," a DBS Group Research report said this week. But even as the market holds its breath, the cartel might reach a decision that will make exhaling difficult.

* Asian leaders rooting for sustained Opec supply

* America to drill on as shale boom dims Opec's market power