Opec’s closing-down sale

This article first appeared in The Edge Financial Daily, on September 14, 2017.
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LIKE a retailer whose mid-season sale shades into an end-of-season clearance, and then into pre- and post-Christmas discount drives, Opec’s production cuts are becoming less an exception than the norm.

The latest reductions were pushed through by Opec and several other producers last November. They will now be extended by at least three months from their planned end next March and possibly into the second half of 2018, people familiar with the matter told Javier Blas, Wael Mahdi and Grant Smith of Bloomberg.

It is not hard to see why. A sharp recovery over the past three months has done little more than bring crude prices back to where they were when the cuts were first agreed upon. Curtailing output is meant to lift prices, not leave them standing still — but maybe another crack at starving the market will succeed.

The risk of extending them, though, is the same that retailers face in a permanent sale. Consumers get used to the new shape of the market, leaving those on the sell side with an enduring disadvantage.

We can see that happening in the way non-Opec producers have stepped up output in recent years. It is easy to forget, but the journey from US$100 a barrel to around half that level started when Saudi Arabia boosted output in 2014 to snuff out the US shale industry (see chart — Go West).

Far from repeating its 1986 success in drowning high-cost rivals, Saudi Arabia has found itself struggling to stay afloat.

Meanwhile, the western hemisphere has boomed. Opec forecasts output from Brazil will rise by 450,000 barrels a day between 2016 and 2018, and by another 380,000 barrels a day from Canada. The biggest winner, however, has been the US, which will add some 1.5 million barrels a day over the period, with 860,000 coming from Texas’s Permian Basin alone. In other words, the oil cartel has not really squeezed the market by cutting output — it has just handed share to arch-rivals.

The long-term picture is not much less alarming. Since the mid-1980s glut, oil supply and demand have grown at a remarkably consistent rate only a little bit slower than global gross domestic product.

Over the past year or so, we have seen something different. The global economy is growing at a relatively robust 3% to 3.5%, yet crude prices are treading water and output growth is only just cracking 2% again after flat lining for almost two years.

The optimistic explanation is that we are seeing a repeat of 1999’s weak patch. China’s voracious fuel demand turned that slide into a bonanza for the oil industry in less than a decade.

A more worrying possibility is that the peak in oil demand is closer than we think. BP plc does not expect this until 2042 but Royal Dutch Shell plc thinks the top could come by 2030; Goldman Sachs Group Inc and Boston Consulting Group both see the chance of a peak in 2024 or 2025 as electric vehicles supplant conventional ones and natural gas replaces crude as a petrochemicals feedstock.

Look at the world’s fastest-growing economies and a worrying picture emerges: China is by far the most oil-intensive. Countries like India, Indonesia and Mexico, which are likely to dominate global growth over the coming decade in the same way that China did since 2000, use far less.

As Bloomberg’s Liam Denning has argued, Saudi Arabia’s determination to sell a stake in the national oil company and loosen its economy’s dependence on the commodity support the case for demand weakness. Should that be the case, expect more output cuts.

That suggests another parallel between the oil market and your local shops: When a retailer’s stock-clearance drives fail to juice the market, they have a nasty habit of turning into closing-down sales. — Bloomberg