Could we see the return of $100 oil?

Oil is currently trading around $62 per barrel and is down 5 per cent during 2018 on the back of a 16 per cent rise in 2017. The key question might be: are the days of low oil prices over? Or perhaps we should be asking: Could we see the return of $100 per barrel of crude?

The recent surge in oil prices took place against the backdrop of declining inventories that was ushered by healthy demand, high OPEC compliance, and heavy maintenance as well as collapsing Venezuelan production.

The oil price movement in the current market scenario is mainly influenced by two key factors. On one hand, OPEC along with some other major oil exporting countries, including Russia, are trying to restrict the supply by curbing their production level at a pre-determined rate. The compliance on agreed production cuts has been unbelievably high. On the other side there is continuous downward pressure on oil prices due to US shale producer’s efforts to capitalise on the opportunity to expand their market share.

There are other important factors on the demand side such as buzz around the electric vehicle industry and the surging share of renewable sources of energy replacing oil demand. These factors also impact the movement in oil prices. However, the magnitude of their impact is less significant in daily price movements given the transition of oil consuming countries to lower their dependence on oil, which won’t take place overnight.

Having said that, data on oil import density which measures import of oil barrels per GDP, highlights a declining trend over the past decade for countries including the US, China and India. To put it in perspective, China’s oil import intensity has fallen from 0.44 per cent in 2006 to 0.24 per cent in 2016, a dip by more than 45 per cent.

If the countries under agreement for production cuts maintain their output in tandem with the target, the oil prices will keep moving upwards. Any decline in the oil inventory and drop in weekly shale output will also drive oil prices. For example, the rise in prices after weekly oil production was reduced by over 1 million barrels per day, due to hurricanes that closed down offshore production temporarily in the US.

The strengthening of global economic growth, which the World Bank estimated at 3.1 per cent for the current year, Saudi Arabia bringing a political risk premium to oil prices with the arrests of Saudi officials and businessmen and the geopolitical rift in the region could keep Brent oil prices on an upward trend in 2018.

Furthermore, opinions are surfacing among some analysts that the International Energy Agency (IEA) has underestimated oil demand. The IEA estimates the growth in oil demand to be 1.3 million barrel a day in 2018 compared to OPEC’s estimate of 1.5 million barrels. Also, there are some concerns that shale wells typically see significant production depletion in the first three years, while fields see output drop off by about 20 to 40 per cent per year without new drilling. This could mean that the industry has to constantly plough more money back into production, just to keep output flat.

However, the prospect of oil prices surpassing the $100 a barrel mark is hard to fathom as of now.

Firstly, the vast improvements in drilling technology and techniques have more than compensated for the depletion in production from shale wells. Shale drillers can access a greater portion of a reservoir than just a few years ago. While shale wells have always suffered from steep declines in their production profiles, overall output has trended up over the past few years, aside from the drop in production levels during the period of extremely low oil prices. The IEA estimates the US will reach 11 million barrels per day of output by the end of 2019, an addition of another 1 million barrels per day from current levels.

It is hard to overstate the significance of this, and the output gains could yet lead to another price downturn.

Secondly, the increase in Brent crude prices by more than 60 per cent since the rally started in mid-June could be a sting to short term demand growth. Many developing countries have taken the opportunity in the lower price environment to reduce subsidies on oil products, and this could amplify the impact of higher crude on what end users pay.

The combination of shale surge with a slowdown in oil demand growth could be the worst possible dampener to OPEC’s production cuts.
What’s more, high oil prices (assuming a scenario where it hits $80 a barrel) could be too much temptation for OPEC members, who may find it hard to stick to the deal and refrain from counteracting the expected surge in US shale production. There is 1.8 million bpd in production capacity ready to be deployed again once OPEC and Russia end their production cuts. This could prove to be another strong resistance in any further rise in oil price.

According to IEA, 2018 will witness a big rise in oil production, supported by strong growth in the US, which is now the joint second largest crude oil producer globally at par with Saudi Arabia, producing 10.2 million barrels a day each. It is now close to becoming the world’s largest crude oil producing nation, marginally behind Russia’s output of 10.95 million barrels per day. With the pickup in non-OPEC supply exceeding the increase in demand, the IEA estimates the world’s need for OPEC oil falling by around 600,000 barrels a day compared with last year.

If these estimates hold true, the possibility of the oil price reaching three figures appears weak.

MR Raghu is managing director of Marmore Mena Intelligence