The end to price declines
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For now, bullish factors resulting from the OPEC agreement seem to be prevailing—macroeconomic factors and geopolitical trends suggest that oil prices will finally stabilize, though challenges remain, U.S. tight oil not least among them

With the agreement reached on November 30, 2016 by OPEC countries on production cuts, the downward phase for crude oil prices seems to be over. The agreement, which came after eight years of misunderstandings, as well as wider-scale conflicts that have gone beyond the perimeter of the organization itself, is undoubtedly of historic importance.

What happened on November 30

On November 30, 2016, in Vienna, the Organization of Petroleum Exporting Countries decided to cut production - as of January 1, 2017 - by 1.2 million barrels per day (bpd) compared with October 2016 levels. The organization’s new production ceiling - from which Libya and Nigeria must be excluded (due to sanctions and consequences of the war), in addition to Indonesia, which is temporarily suspended from the group - will be around 32.5 million bpd.

Meanwhile, 11 non-OPEC producers have promised to reduce their extractions to a total of 558,000 bpd. More precisely, the Russian Federation by 300,000 bpd, followed by Mexico (100,000 bpd), Oman (40,000 bpd), Azerbaijan (35,000 bpd), Kazakhstan (20,000 bpd) and others (Bahrein, Brunei, Equatorial Guinea, Malaysia, Sudan and South Sudan).

In the event that these cuts were to be implemented, in mid 2017 a gradual rebalancing between demand and supply would occur, with prices consistently above $50/b. On January 31, 2017, North Sea Brent Crude and West Texas Intermediate crude oils were priced at $55.48/b and $53.32/b respectively, gaining approximately 15 percent since OPEC and non-OPEC producers committed to reducing extractions.

Latest data and estimates on oil

According to data provided by the Oil Market Report on January 19, 2017, in December 2016, global oil supply fell by 0.6 million bpd from the record level of 98.2 million bpd reached the previous month. This decrease involved both OPEC and non-OPEC countries. The Cartel’s crude oil production fell by 320,000 bpd, amounting to 33.09 million bpd.

According to data provided by the OPEC Monthly Oil Market Report, on January 18, 2017, in 2016, the Organization of Petroleum Exporting Countries produced, on average, 32.418 million bpd of crude oil, a sharp increase from the 31.470 million bpd produced in 2015.

The IEA estimates that in 2016 the global oil supply increased by 0.3 million bpd from the previous year, to the extent that OPEC’s record extractions have more than offset the 0.9 million bpd decline in non-OPEC output, despite the fact that the Russian Federation’s production has increased by 230,000 bpd, reaching 11.2 million bpd several times, a record for the post-Soviet era.

Forecasts for 2017, however, suggest a reversal of the non-OPEC trend, whose supply is expected to increase by 385,000 bpd, of which as much as 320,000 bpd from the U.S.

In accordance with data published by the Oil Market Report of December 13, 2016, total stocks in OECD countries declined in November 2016 for the fourth month in a row. Preliminary estimates at the beginning of December reveal a drop, in absolute terms, of 82 million barrels from the record reached in July. Nevertheless, the overall amount of stocks still remains greater than 3 billion barrels.

Global oil demand is expected to grow by 1.5 million bpd in 2016 and by 1.3 million bpd in 2017. Despite the slight slowdown, this value is still higher than the annual average of 1.2 million bpd recorded at the start of the 21st century.

Specifically, China will once again drive consumption, driven by its 6.7 percent economic growth recorded in 2016. The main state-owned company - CNPC - has estimated for 2017 a record of 11.88 million bpd of crude oil (+3.4 percent), with net imports up by 5.3 percent to 7.95 million bpd. In all likelihood, these import increases will continue beyond 2017, given that the Chinese government expects that in 2020 its output - amounting to approximately 4 million bpd - will decrease by seven percent from 2015. Analysts at Wood Mackenzie estimate an even steeper decline, to 3.53 million bpd in 2020.

Although from 2005 to the beginning of 2015, much of the incremental crude oil production worldwide came from the U.S., the oversupply that has characterized the oil market in the last two years has been almost entirely due to OPEC’s non-compliance with the production ceiling.

The IEA estimates that in 2016 the global oil supply increased by 0.3 million bpd from the previous year, to the extent that OPEC's record extractions have more than offset the 0.9 million bpd decline in non-OPEC output, despite the fact that the Russian Federation's production has increased by 230,000 bpd, reaching 11.2 million bpd several times, a record for the post-Soviet era.

The role of monetary policy

On December 14, the Federal Reserve raised interest rates by 25 basis points, bringing them to a range of 0.50-0.75 percent. The Chair of the U.S. Central Bank, Janet Yellen, justified this move - which investors have been waiting for several months and which the market had already started to expect, given the appreciation of the dollar since October 2016 - claiming that ''the labor market seems to be going the same way it did before the recession''. What were the first consequences?

-Increase in yields. For the first time, U.S. 10-year Treasury Debt yields reached an annual record of 2.3809 percent, precisely at the time of the OPEC agreement. After that, they continued to grow, reached a maximum of 2.5967 percent on December 15, to then close the year at 2.4443% (2.4531 on January 31, 2017).
-Strengthening of the dollar. In November, the dollar opened  at €1.1025/$, steadily appreciating for the entire month to close at €1.0635/$ at the time of the OPEC agreement. This trend continued, with the dollar reaching its highest level since 2002 on December 20, at €1.0364/$. During the first month of 2017, the dollar clearly reversed its trend, depreciating to €1.0755/$ on January 31, 2017, in the wake of Donald Trump inauguration speech, which seemed to suggest the U.S. would turn toward protectionism.

From November 8, 2016, the date of the US presidential elections, to January 6, 2017, the dollar gained eight percent over the euro. The new U.S. President’s promises in favor of deficit spending policies and, above all, reduced rates to companies that had repatriated funds held abroad, supported a bullish trend. After that, the impression is that, in the market, fears have prevailed due to protectionism, in parallel to the criticism that the White House directed at Germany, guilty of favoring their exports due to an underestimated euro.

Economic considerations

The increase in interest rates by the Federal Reserve decided on December 14 may not lead to the opening of a new markedly bullish course, as shown by the subsequent decision made by the Central Institute which, on February 1, kept rates unchanged. Despite Yellen’s statements, the U.S. labor market has a significant grey area, starting with the fact that 95 percent of the jobs created in the Obama era are part-time.

The Trump administration, in addition to inheriting 43.2 million Americans who use food stamps (government subsidies for food) and public debt of almost $20 trillion, following the $9 trillion increase during the previous presidency (+86 percent), will have to carefully assess the consequences of a significant strengthening of its own currency. According to economist Guido Salerno Aletta, ''America is changing economic strategy because it can no longer maintain its role as a global locomotive growing on foreign debt. During the Obama presidency, net debt worsened exponentially, growing from -$2,627 billion in 2009 to -$7,281 billion in 2015''. The impression, therefore, is that an appreciation of the dollar would be "disastrous."

Winners and losers within OPEC

The OPEC agreement represents a serious political defeat for Saudi Arabia and its allies in the Gulf, starting with Qatar and the United Arab Emirates, the effects of which will have repercussions that go far beyond the balances with the organization. The Saudi strategy, implemented since September 2014 and aimed at flooding the oil market in order to cause prices to decline, had, as its primary goal, to further weaken Iran which, at the time, was still grappling with the sanctions on nuclear power. This option, in addition to causing problems for the States with a high tax break-even point within the organization (starting with Iran itself, but also Venezuela, Algeria, Nigeria and Ecuador), would have led to the expulsion of high-cost producers from the market. This plan was not implemented - if not partially and, above all, not in the times that Riyadh had initially planned - for a number of reasons, starting with the military defeat in the war in Syria.

In addition, the previously reported data reveal that several unconventional producers have since been expelled from the market, while others have had the ability to resist, by significantly reducing extraction costs. Moreover, the petro-dictator succeeded in the attempt to stop the recovery of Iran’s output after the end of the embargo decreed on July 14, 2015 and, at the same time, saw its own public deficit flare up due to the collapse in income from oil exports. Despite having lost $100 million in revenue due to sanctions and the collapse of crude oil exports, Iran came out top from the Syrian military conflict and, therefore, from the clash with Saudi Arabia, as evidenced by the production ceiling of just under 4 million bpd established by the agreement (close to that of the pre-sanction period). That said, despite Iranian exports having reached 2.44 million bpd again in October 2016, Trump’s doubts regarding the nuclear deal and pro-Israel statements would suggest to Tehran not to declare victory, even taking into account that its oil & gas industry needs hundreds of millions of dollars in order to be modernized. Iraq also came out victorious from the clash with the Saudis: proof of this is in the replacement of supplies from Riyadh with those from Baghdad to Cairo’s supply, previously suspended by the Saudis due to General al-Sisi’s political and military support to al-Assad.

The Russian Federation

As one of the commodity producing states, the Russian Federation has been the main winner since the agreement reached by OPEC & non-OPEC countries is the direct result of its success in Syria.

After years of economic crises due to the sanctions imposed by the West, which ''were much more effective due to low international oil prices'', according to Ambassador Dan Fried, coordinator for the Sanctions Policy at the U.S. Department of State, Moscow can look to the future with cautious optimism thanks to the recovery of the barrel, the consequent strengthening of the ruble - at an 18-month high, after having reached 59.22 rubles/$ on January 24 - and the constant purchases of gold by the Central Bank of Russia which, in October, reached a record high since 1998.

The Oil Pax, the price of the barrel and Italy

According to economist Giuseppe Masala, ''with Trump’s announcement of the appointment of Rex Tillerson, C.E.O. of Exxon Mobil, as secretary of state, it should be made clear that an era has truly ended... This should restore relations between the two states on a path of mutual trust that could ensure a great deal in both the Middle East and Ukraine.

This deal will most likely be remembered by historians - should it go ahead - as the Oil Pax''.

Given that a new reset in international relations between the U.S. and the Russian Federation will not be at all easy, what major geopolitical events occurred in December 2016 leading to the possibility of achieving the Oil Pax, in addition to Tillerson’s appointment and the OPEC & non-OPEC agreement?

-Entry of the consortium comprising Swiss Glencore and the Qatar Investment Fund (QIF) into the shareholding of Rosneft - 50 percent controlled by the Russian state - for a value amounting to €10.5 billion (19.5 percent of the capital), with the guarantee of a pool of banks (including Russian) headed by Italy’s Intesa Sanpaolo. Through this transaction, Russia benefits from Qatar going from military enemy to business partner, by bringing together the interests of the two largest natural gas producers in the world.
-Rosneft purchased 30 percent of the capital of the Shorouk Concession, offshore Egypt, where the major Zohr gas field is located, from Eni for $1.57 billion. In doing so, the company headed by Igor Sechin entered into the gas market but without prejudice, for the moment at least, to the interests of the other Russian energy giant, Gazprom, with which several tensions existed. The Russian Federation therefore managed its attempt to ''place another foot in the Mediterranean'' as stated by Gay Caruso, Energy and National Security Program Analyst, at the Center for Strategic and International Studies.

In the event that the Oil Pax is actually reached, it will promote a stabilization of current barrel prices and, at the same time, it would create the conditions for a possible, albeit moderate, increase. In parallel, for Italy, the doors would be thrown open for anything but a secondary scenario: Italy would, in fact, look towards the possibility of playing a pivotal role, not only in the Mediterranean, but also between the White House and the Kremlin.

Potentially bearish factors

The factors that could curb oil prices are: delays in the #OPECagreement, and increased output in #Nigeria, #Libya and #US #tightoil

The main factors that could curb oil price increases, if not reverse their trend, are possible delays or the failure to implement the agreement, the rapid recovery of Nigerian and Libyan output excluded therefrom, and a significant increase in U.S. tight oil production.

-Implementation. Currently, members of the organization are complying with their obligations in terms of predetermined amounts and times. The Saudis–who had to cut 486,000 bpd, amounting to a total output of 10.058 million bpd - are already ''slightly under 10 million'', according to the announcement of Minister Khalid al-Falih, in Abu Dhabi, during the Atlantic Council Global Energy Forum. Even the main non-OPEC producer, the Russian Federation, has already reduced its production by 130,000 bpd, versus the planned 100,000.

-Nigeria and Libya. Nigeria and Libya will unlikely be able to increase their output in the coming months by an amount that would significantly affect global supply. Specifically, the former Italian colony is far from the 1.6 million bpd extracted during the final period of the Muammar Ghedaffi era. That said, the impression is that the country’s stability - a precondition for an increased oil output - may come more easily from the consolidation of power by General Khalifa Haftar, supported by Moscow, than from the current government of Fayez al Sarraj, officially recognized by the UN and strongly backed by Obama, but not necessarily from Trump, in the future division of the spheres of influence between the United States and Russia in the Mediterranean and Middle East. If so, for Italy, it would lead to a considerable problem, given the support provided to the current government of Tripoli and the presence of Eni terminals at Mellitah, in Tripolitania.
-US Tight Oil. Both the EIA and OPEC forecast that U.S. crude oil production will increase in 2017, to around nine million bpd. After reaching a record 9.7 million bpd in April 2015, it fell to a low of 8.4 million bpd in July 2016. After that, in the wake of the increase in barrel prices, U.S. crude oil output again reversed its trend, reaching 8.9 million bpd in the week of January 20, 2017. This was possible thanks to the recovery of unconventional oil - estimated at around 4.7 million bpd in February 2017 - and the start-up of dozens of drills, reaching a total of 712 - of which 566 (79.5 percent) oil, 145 gas (20.4 percent), plus 1 mixed - according to data provided by Baker Hughes. Two factors could hinder this trend.

 

First, the need to meet the increased demand means that frackers have to restart less productive wells, with a higher breakeven than those currently used. This will result in increased costs, which the Wall Street Journal has already estimated at 10-20 percent during this winter. The risk, therefore, is that frackers will need higher than existing per-barrel prices, in order to increase their output.

Secondly, the current decline in the rates of energy junk bonds and the simultaneous increase in interest rates by the Fed is significantly reducing the gap between the respective yields - already below 4 percent - placing new clouds on the horizon for several American companies operating in the oil & gas sector.

In 2016, the decreased output of US crude oil coincided with increased imports. More precisely, in November, output exceeded 8 million bpd (8.054 million bpd) for the fifth time that year.

Excluding March, it is interesting to note that the other four months in which this situation occurred are subsequent to 2016, the month after which American crude oil extractions started to increase again. That said, the average for imports in the first 11 months of 2016 amounted to 7.879 million bpd, up from the 7.344 million bpd imported in 2014, and the 7.363 million bpd in 2015.

The main macroeconomic and geopolitical factors we analyzed in the text suggest a stabilization of black gold prices at just over $50/b during the first months of 2017. For now, bullish factors seems to be prevailing. That said, should such conditions occur, the amount of that increase does not currently seem enough to determine a significant recovery of output by high-cost producers, starting with unconventional producers.