OPEC action not cutting it

In large measure the view is that there will be some recovery in energy-sector GDP, government revenues from the energy sector, and foreign exchange earnings as the new gas fields come on stream later this year. The improvements are based on the hope of new production and more favourable prices. Let us review what has been happening with the international price of oil to determine how our hopes, policy designs and policy actions will be affected.

The current price of WTI crude oil as of May 5, 2017 is US$46.22 per barrel. What has happened in the market resulting in such a perverse result for us?

Perhaps we can start by indicating that the international oil market is all about supply and not demand at present. Several issues are affecting supply. The first is that US shale production is winning the fight with OPEC. The hope that OPEC cuts will lead to a firming up of oil prices has not occurred. Shale producers have demonstrated that their production is more responsive at much lower prices, signalling an improvement in efficiency.

We have seen incremental increases in shale production below US$50 a barrel. The Energy Information Administration has stated that US oil production has risen by 840,000 barrels a day since last October to 9.3m barrels, with output up by 28,000 barrels a day in the final week of April - the highest level in almost two years. The US Energy Department expects production to hit 9.7m barrels a day in 2018 – breaking the record set in 1970. This is new for the market. The assumption that such a phenomenon was not possible has proven to be a bad one. This surge in production in the US, driven by drillers flocking to American shale basins at a time of subdued global demand, has sent the oil price tumbling.

Secondly, within OPEC there has been little allowance for countries such as Libya, demonstrating that the cuts have ben woefully inadequate. Libya resumed production from its largest field last week, adding more than 200,000 barrels a day to its production.

While OPEC has implemented the curbs, a rebound in U.S. shale output and stubbornly-high stockpiles show the world’s three-year crude glut isn’t shifting. Where is all this coming from? Figures from industry experts Baker Hughes show the number of oil rigs operating in the US has more than doubled in the last year, rising by 450 to 870. The rig count in Canada has also risen, by 48 to 85, but it is down by 42 to 943 in the rest of the world. Clearly North America has taken and pursued a different strategy. The geopolitical objectives are certainly different from oil producers such as Iran, Saudi Arabia and Iraq, whose objectives are stabilising oil prices between US$50- US$60.

OPEC is already showing near-perfect compliance in delivering it’s pledged 1.2 million barrel-a-day production cut and an extension looks likely. Care has to be exercised since the risk of a higher cut is that it could trigger too strong an increase in prices and support US shale producers. This will be counterproductive to their objectives of forming prices at some higher level.

If OPEC changes strategy, Saudi Arabia would lose face. You can’t say you want lower inventories, and after a few months of cutting production just give up.

The World Bank does not see grounds for concerns or the need for a revision of its oil price outlook in view of the recent decline. Only time will tell if they are right. The date of the formal OPEC meeting on May 25 in Vienna is obviously “the key date to watch” in respect of oil prices. The decisions taken in Vienna could have implications for whether the price of oil settles higher. This is very important for us here since changing oil price is one of two variables that can affect energy sector revenues for the government. If OPEC extends it production cuts and increases it, we need to take a look at the market response and whether inventories start to fall. It does not help that China’s demand for oil is also falling as its economy slows. For us here maybe it is time we start preparing an alternative strategy that is not so heavily dependent on oil leading our recovery.