Oil prices unlikely to rise beyond $55 soon as glut lingers

As Opec reduces production, new volumes add up elsewhere outside the cartel. FILE PHOTO | AFP  

By GEORGE WACHIRA

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Summary

• Oil prices had previously dropped from above $100 in mid 2014 to as low as $26 early last year prompted by a number of producers in Opec who over-produced.
• Price increases are motivating more production elsewhere as profitability improves.
• Opec may have failed to appreciate and consider changing global oil supply, demand and price dynamics.

Indications are that global crude oil over-supply will linger on much longer, and this will slow down the upward movement of prices. When the Organisation of Petroleum Exporting Countries (Opec) decided last November to strengthen oil prices by reducing production by 1.8 million barrels per day(bpd), global oil prices complied and increased to a range of $50-55.

But this increase was fuelled more by speculative push by traders than by tangible net decrease in global stocks. As Opec reduces production, new volumes add up elsewhere outside the cartel.

Oil prices had previously dropped from above $100 in mid 2014 to as low as $26 early last year prompted by a number of producers in Opec who over-produced to flood the market and price-out high cost producers who were gradually taking over Opec market shares. It is this price collapse that the Opec is now correcting with production cuts which so far have raised prices to $50-55.

Last week, oil prices crawled back to about $47, prompting a new conversation centred on the sustainability of Opec strategy to reduce production to force prices up. In reality, Opec plans and intentions appear illogical in that any increase in prices achieved by Opec is having the reverse effect.

Price increases are motivating more production elsewhere as profitability improves. And this is exactly what is happening with the US shale oil ventures.

The effectiveness (or futility) of the “trial and error” experiments by Opec is what they will be reviewing in their meeting later this month. They will have to decide whether to renew, modify or discontinue with the ongoing production cut strategies.

Opec may have failed to appreciate and consider changing global oil supply, demand and price dynamics. On the supply side, in the near to medium term, global production is likely to continue increasing.

This is because the capital and technology deployed in new and difficulty oil fields during the 10 years of high oil prices are now mature and producing projects. Even at $50 these assets may be producing profitable oil which Opec cannot wish away.

After the recent oil price collapse, the US shale oil producers are now able to produce more crude cheaper as they embraced new production methods and technologies. I read a recent caption that improved technology will enable BP to extract an extra one billion barrels of oil from existing fields in the Gulf of Mexico. Russians are poised to move into the Arctic region to drill more oil.

On the demand side, growth in global oil consumption is slower than growth in new oil production. Energy use efficiencies, greener and cleaner alternatives, and new vehicle technologies are all conspiring to slow down oil demands.

It is the simultaneous scenarios of increasing production and decreasing demands that will continue to sustain over-supply and depressed prices in the short to medium term.

This is on course unless there is a substantial geopolitical incident that significantly impacts the oil supply systems, or the Opec decides to go for a brave experiment on much larger production cuts.

For a net importer of oil like Kenya, future depressed prices are a good economic story due to reduced pressure on balance of payments and cost of energy.

However, as a prospective oil exporter, this is not an encouraging story as upstream investors will remain shy and slow in committing timely investments to develop and commercialise our oil reserves.

Uganda, on the other hand, appears determined to proceed to commercialise their oil finds (exports and refining) at the current prices. Two of their investors are heavily capitalised and can take risks with future oil prices. Uganda’s larger oil volumes also give them stronger economies of scale.

Tanzania is essentially a natural gas story which is not adversely impacted by the oil prices as ready markets exist in the Far East. Tanzania is also already locally commercialising some of their natural gas discoveries through power generation and feed to industries.

Whatever plans the Opec decide to pursue later this month, they had better be anchored on realistic supply and demand fundamentals.