The OPEC oil cartel has issued its strongest plea to date for a pact with Russia and rival producers to cut crude output and halt the collapse in prices, warning that the deepening investment slump is storing up serious trouble for the future.
OPEC Secretary-General Abdullah al-Badri said the cartel is ready to embrace rivals and thrash out a compromise following the 72 per cent crash in prices since mid-2014.
“Tough times require tough choices. It is crucial that all major producers sit down and come up with a solution,” he told a Chatham House conference in London.
Al-Badri said the world needs an investment blitz of $10 trillion to replace depleting oil fields and to meet extra demand of 17m barrels per day (b/d) by 2040, yet projects are being shelved at an alarming rate. A study by IHS found that investment for the years from 2015 to 2020 has been slashed by $1.8 trillion, compared to what was planned in 2014.
Al-Badri warned that the current glut is setting the stage for a future supply shock, with prices lurching from one extreme to another in a deranged market that is in the interests of nobody but speculators. “It is vital that the market addresses the stock overhang,” he said.
Russia’s oil group Vice President Lukoil Leonid Fedun said that the OPEC policy had set off a stampede, comparing it to a “herd of animals rushing to escape a fire”. He called on the Kremlin to craft a political deal with the cartel to overcome the glut. “It is better to sell a barrel of oil at $50 than two barrels at $30,” he told Tass.
This is a significant shift in thinking. It has long been argued that Russian companies cannot join forces with OPEC since the Siberian weather makes it hard to switch output on and off, and because these listed firms are supposedly answerable to shareholders, not the Kremlin.
Fedun said OPEC will be forced to cut output anyway. “This could happen in May or in the summer. After that we will see a rapid recovery,” he said.
He accused the cartel of incompetence. “When OPEC launched the price war, they expected US companies to go under very quickly. They discovered that 50 per cent of the US production was hedged,” he said.
Fedun said these contracts acted as a subsidy worth $150 million a day for the industry though the course of 2015.
“With this support shale producers were able to avoid collapse,” he said.
The hedges are now expiring fast, and will cover just 11 per cent of output this year. Iraq’s premier, Haider al-Abadi, was overheard in Davos asking US oil experts exactly when the contracts would run out, a sign of how large this issue now looms in the mind of OPEC leaders.
Fedun said 500 US shale companies face a “meat-grinder” over coming months, leaving two or three dozen “professionals”.
Italy’s oil group Eni Head Claudio Descalzi said OPEC has stopped playing the role of “regulator” for crude, leaving markets in the grip of financial forces trading “paper barrels” that outnumber actual barrels of oil by a ratio of 80:1.
The paradox of the current slump is that global spare capacity is at wafer-thin levels of 2 per cent as Saudi Arabia pumps at will, leaving the market acutely vulnerable to any future supply-shock. “In the 1980s it was around 30 per cent; 10 years ago it was 8 per cent,” said Descalzi.
Barclays said the capitulation over recent weeks is much like the mood in early 1999, the last time leading analysts said the world was “drowning in oil”. It proved to be exact bottom of the cycle. Prices jumped 50 per cent over the next twenty days, the start of a 12-year bull market.
Norrish said excess output peaked in the last quarter of 2015 at 2.1m b/d. The over-supply will narrow to 1.2m b/d in the first quarter as of this year as a string of OPEC and non-OPEC reach “pain points”, despite the return of Iranian crude after the lifting of sanctions.
By the end of this year there may be a “small deficit”. By then the world will need all of OPEC’s 32m b/d supply to meet growing demand, although it will take a long time to whittle down record stocks.
Norrish said the oil market faces powerful headwinds. US shale has emerged as a swing producer and will crank up output “quite quickly” once prices rebound.
Global climate accords have changed the rules of the game and electric vehicles are breaking onto the scene.
Yet the underlying market is tighter than in 1999, when there was ample spare capacity, the geopolitical risks are much greater in the Middle East.
Barclays said extreme positioning on the derivatives markets has prepared the ground for a short squeeze. “Unhedged short positions held by speculators are huge so there is certainly the potential for a steep move up in prices at some point,” it said.