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Catching a Falling Financial Knife

OPEC Warned On 2014 Crude Oil Supply Glut

Commodities / Crude Oil Jan 21, 2014 - 02:33 PM GMT

By: Andrew_McKillop

Commodities

TIMELY ADVICE TO OPEC
Leo Drollas, the head of the Saudi-backed, London-based Centre for Global Energy Studies in a 3 December interview with New Europe on the eve of the 4 December OPEC meeting, itemized several supply-side reasons why present high oil prices are not forever. Apart from the USA's record-breaking output of oil driven by its shale-oil production, Drollas said: “Next year, Iraqi oil will increase by 300,000 barrels a day, we think at least, there will be 250,000 more from Venezuela, there will be possibly 1 more million barrels from Iran, when Iran comes back, and Libyan oil should return”.


For him, the bottom line was simple: “....so we have a glut on the horizon which should lead to lower prices.”

To be sure the 4 December OPEC meeting was shuffled aside by analysts – because no decisions were taken, and in the absence of any change, oil prices were firmly pushed upward on markets by brokers and traders hungry for quick gains, drawing upside logic from US employment growth. Saudi Arabia’s Oil Minister Ali al-Naimi in interview, December 4, shrugged off the prospect of a glut of new and additional oil supply in 2014. “Everyone is welcome to put in the market what they can. The market is big and has many variables. When one comes in another comes out,” he said. Brave words to be sure, but the political impact of Iran's declared intention to reassert its traditional role as OPEC's second producer, after KSA, and put more oil into the market as sanctions wind down should send warning signals to the few members of OPEC able to cut output without dangerously weakening their economies, civil societies and ruling parties. That is KSA, UAE and Kuwait.

At least three member countries not including Iran have signaled, in their own way, that they expect or believe it will be the job of KSA, UAE and Kuwait to cut their output. Venezuela’s Energy Minister Rafael Ramirez, and Libya’s Oil Minister Abdulbari al-Arusi both claimed in interview at the 4 Dec meeting that the present theoretical 30 million barrels a day (Mbd) official production cap or quota limit set by OPEC, to which Iraq is not bound and other countries largely ignore it, is a bulwark against oil price erosion. Iraq's Oil Minister Abdul Kareem al-Luaibi has several times rejected any question of Iraq limiting the growth of its oil production and oil exports, as an issue of Iraqi “sovereignty and national pride”. .

The potential for Venezuela, Libya and Iraq to voluntarily limit production is therefore low or zero. In the case of Iran it is negative – Iran will make all efforts to increase its production and exports, not only for “national pride” or to reassert its regional political clout, but also to head off serious economic difficulties made worse by the sanctions regime and a major fall in its oil exports and revenues since 2011.

SUPPLY GLUTS PAST AND PRESENT
 The OPEC Annual Statistical Bulletin for 2013 skates around the unrealistically low 30 Mbd quota or cap, by including Iraq in the data and saying that for year 2012, OPEC's total production was a day average of 32.424 Mbd, producing total OPEC national revenues of a suspiciously exact $1688.2 billion the same year. Staying with its Annual Statistical Bulletin, this lists KSA's daily average oil production as 9.763 Mbd in 2012 – but current production this year has included monthly averages above 10.5 Mbd although according to Saudi oil industry sources cited by Reuters, 8 November, the country's rulers intend to “throttle back” to about 9.75 Mbd by year-end.

To be sure the potential for simultaneous ramping-up of output from all four of the above-cited countries, and possibly Angola, in 2014, is either unlikely or in no way certain. Neither Iraq nor Libya can count on civil peace and both countries could literally break apart under worst-case civil, ethnic and political strife. However, the potential for Iran raising total output well above its 2012 rate as published by OPEC, of an average 3.729 Mbd, can be considered likely. Likewise Iraq's potential output growth – in the absence of intensified Sunni-Shia conflict – may be considerable and could exceed the 0.3 Mbd forecast by Drollas. Oil output by the breakaway Kurdish north of Iraq is also growing. Outside the Arab OPEC (OAPEC) states, high oil prices through 2005-08, and again since 2010 have lifted production in other OPEC members, and outside OPEC, spurring exploration and development. IEA data for late 2013 shows world oil output increased by over 2.5% in 2012-2013.

Backtracking to the pre-2000 context of very low oil prices (in 2013 dollars, under $20 per barrel for prolonged periods) which held through 1986-99, this seriously depressed oil investment and led to major declines in total oil output by the majority of OPEC states. Coupled with political turmoil, the reduction in total oil output capacity, compared to the previous high-oil-price period of 1973-85 was in several cases massive. Libya, for example, was then able to pump as much as 3.3 Mbd on a year-round basis, compared with at most 1.6 Mbd today; Iraqi output could exceed 4.5 Mbd, compared with 2.9 Mbd today, Venezuela's yearly average output on occasions reached 3.8 Mbd, close to 1 Mbd more than current production.

Taking these 3 OPEC states and Iran, their combined production today is as much as 5 Mbd less than their previous combined peak output. The big question is how much of the “lost capacity” can be recovered and reinstated?

Prior to the 1986 oil price crash (a 65% price decline in 6 months), oil investment driven by high prices had lifted production – but world economic conditions of very slow economic growth and weak or absnet oil demand growth similar to today sparked a price war between producers, ironically led by Saudi Arabia. After a short period of trying to “defend prices” in 1986-88 through cutting output by as much as 4.5 Mbd, it switched back to “defending revenues” by reinstating maximum production, albeit at much lower barrel prices. This focuses our attention to what amount of “fat to trim” is needed to prevent a price rout in 2014.

Producer logic and revenue needs – if not politics – identifies the self-described “core Arab OAPEC producers” – KSA, UAE, Kuwait – as needing to cut their output in 2014 by at least 1.75 - 2 Mbd, if they want to defend prices. If they do not cut by that amount, unless there are serious and prolonged civil strife or civil war conditions in Libya and Iraq, major political difficulties in Venezuela, reinstated nuclear sanctions against Iran, and a major decline in oil output growth outside OPEC, oil prices are likely to fall by $25 a barrel or more in 2014. This we can note would only be a 25% cut in prices – compared with the 65% cut in 1986 – for reasons including much higher present-day breakevens needed in a higher production-cost environment.

By Andrew McKillop

Contact: xtran9@gmail.com

Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2013 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisor.

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