Investors have been burnt before, and are now skeptical that OPEC will overcome its internal divisions and agree to do something about chronically low oil prices. But could that be the wrong conclusion to draw? Some contrarian voices argue that now is precisely the time to look for a change of stance, in which the fractious group at last gets its act together.
This week’s gathering of OPEC ministers in Algeria looks unlikely to spring surprises as the group again struggled for consensus. Investors have learnt that just because an oil minister from one or another country talks about agreement, that does not mean something will happen. Oil company shares have taken a hit as investors look elsewhere, including at other, more buoyant commodities, participants at an S&P Global forum heard on Tuesday.
But Paul Horsnell, global head of commodities research at Standard Chartered bank, is among those who argue it is too soon to write off OPEC, a group that, when natural gas liquids are included, accounts for well over a third of global oil production and has been expanding its membership.
At Tuesday’s forum he argued that unlike in 2008, when OPEC quickly reacted to the global financial crisis to effectively reduce oil prices, the group has long had difficulty dealing with questions of over-supply. In his analysis, it is above all on the supply side that the roots of the current slump lie – in the rise of US shale and the resurgence of Iran, for example. Standard Chartered believes demand is already out-stripping supply this month, spelling a “balanced” market, with the proviso that a large buildup of stocks has yet to be shifted.
In Horsnell’s view, OPEC has lacked consensus because some members, most obviously Saudi Arabia, wanted other parts of the industry outside OPEC to take some of the strain and help to curb output. But that does not mean sticking to high production come what may. While Saudi messages have not always been consistent, energy minister Khalid al-Falih reiterated on Tuesday an oft-repeated Saudi line: that prolonged low oil prices risk creating instability further down the line.
It is a view echoed by Horsnell, who argues that big international oil companies can adjust their cost base, “but not to the extent that $45 oil brings you any kind of profitability. This can’t be long term, no matter what’s going on in the US – $45 is too low for oil supply to grow,” he said.
“Higher prices are needed. Otherwise we face the other problem, which is a severe supply crunch in a couple of years’ time, when $100 again starts looking likely.”
As for OPEC, “something that gets all that attention can’t be totally irrelevant,” Horsnell said.
“Up to now they haven’t all wanted agreement. This is the first stage where suddenly various of the bits are starting to come together, which makes it possible to start thinking about an agreement and just feeling out whether there’s going to be a deal that could be put together – it doesn’t mean they’re going to do it this week, but at last everyone can at least start talking about it,” Horsnell said. “Up to now it’s not that they’ve been trying to do it and failing.”
“If there comes a point where it’s in the interest of the members to get some kind of agreement together, it will happen. This one has been much harder because of the nature of the cycle, because of the insistence that OPEC shouldn’t do all the work, that non-OPEC producers have to at least provide some kind of support.”
He went on to stay that non-OPEC countries are now sharing in the pain of low oil prices, with an estimated $700 billion of projects postponed or cancelled by the industry globally. “There is reason to believe that [OPEC] will at least make the first stages of some kind of agreement,” he said, with the next OPEC meeting in November a potential staging post.
“We’re just at the point where they all feel they have some kind of common interest to talk about,” perhaps involving Saudi Arabia pulling back production to January levels. “It’s a subtle change, may not lead to immediate change, but I think it’s just part of that slight impatience that why aren’t things getting better a little bit quicker – if prices were $5, $10 higher we wouldn’t have this discussion.”
Amid mixed views on the likelihood of OPEC action, Dave Ernsberger, global head of oil content at S&P Global Platts, told the forum the demand side of the oil market remained an issue, in particular China’s lackluster demand, for which rising Indian demand is still no substitute.
“The demand picture is very unsettling for OPEC and really all producers of crude and refined products right now, most prominently because of the slowdown in the growth of the Chinese market,” Ernsberger said. “China has returned more incremental demand for global oil markets in the last five years than any other country in the world and more than almost all of those other countries combined.”
Jodie Gunzberg, global head of commodities and real assets at S&P Dow Jones Indices, confirmed that OPEC’s reluctance to restrain production was having an effect on non-OPEC output, in particular on US shale oil production companies.
Optimism among energy investors seen earlier in the year, despite rock-bottom oil prices, appeared to have dissipated, she said. In February “we saw the S&P 500 energy stocks really start to out-perform bonds for the first time in several months…Now we’ve seen that completely reverse. It’s one of the few sectors now that shows a lot of pessimism. We see the stock market in energy down almost 2% this month and the bonds are basically flat.”