Assessing pace, timing of oil price recovery

At the time of this writing, a meeting of the OPEC members in Algiers, Algeria, concluded with a decision for an OPEC-14 production target ranging between 32.5 and 33.0 MMb/d, "in order to accelerate the rebalancing of the market," the organization said in an official statement.

Paganie
PaganieDavid Paganie • Houston

At the time of this writing, a meeting of the OPEC members in Algiers, Algeria, concluded with a decision for an OPEC-14 production target ranging between 32.5 and 33.0 MMb/d, “in order to accelerate the rebalancing of the market,” the organization said in an official statement.

The statement said that OPEC will appoint a committee to “study and recommend the implementation of the production level of the member countries” at the Nov. 30 meeting in Vienna, Austria.

Following this news, WTI gained nearly 8% in the subsequent, two-day trading period and settled at $48.24/bbl.

Indeed, market rebalancing and thus a higher oil price is front of mind of OPEC, as many of its members are losing considerable oil export revenue. OPEC members’ net oil export revenue is forecast to fall to $337.9 billion this year, a drop of 16% from 2015 and 55% from 2014, according to a recent Bloomberg report citing EIA data. This would be the lowest level since 2004.

OPEC crude production in August was 33.47 MMb/d, led by record or near-record output from Kuwait, UAE, and Saudi Arabia. Meanwhile, Iraq had increased its output, and Iran reached a post-sanctions high. Overall OPEC supply stood 930 Mb/d above a year ago, according to IEA data.

OPEC Gulf behavior, in particular, Iran and Saudi Arabia, is one of four key drivers in the short term that will dictate the pace and timing of an oil price recovery, McKinsey Energy Insights (MEI) finds in a recent outlook report. The other drivers are GDP growth, decline in producing fields, and a slowdown in US light tight oil (LTO) production.

The analytics group modeled four scenarios – fast recovery, slow recovery, under-investment, and supply abundance. The latest trends point to a slow recovery scenario, with another six months for oversupply to disappear and another six-12 months to burn excess inventories, according to the report.

The trends that factored into the analysis include: low but stable GDP growth at 2.8% per annum that is expected to increase oil consumption by about 3 MMb/d between 2015 and 2019; a resumption in the growth of LTO production; and an accelerated decline in mature fields. All of these factors are expected to contribute to the ongoing rebalancing.

The key downside risk, the report suggests, is that OPEC Gulf states have the capacity to add more than 4 MMb/d of incremental production by 2019, potentially holding back oil prices into 2018-19. Moreover, OPEC’s proposed cap would help to reduce the excess supply only if it were not offset by gains in non-OPEC output, and global stockpiles of crude oil would remain high.

Over the longer term, ongoing cost suppression measures could lower average marginal costs to $65-75/bbl, MEI adds, driven bydeepwater and LTO plays.

On the supply side, in addition to OPEC Gulf crude production, MEI sees unconventionals and offshore resources playing an important role in replacing the 34 MMb/d decline in conventional basins through 2030. The industry must replace 2-3 MMb/d of production every year to offset the declining production in mature basins, it says.

Other noteworthy findings for the offshore market include steady deepwater production growth led by the US and Brazil. The MEI report also projects that some 40% of global production is expected to come from unsanctioned projects, to offset declines in existing fields by 2030.

In summary, MEI suggests that the latest market trends support a slow recovery scenario with the market balancing by mid-2017 at about $60/bbl. However, a definitive implementation plan by OPEC this November to curtail production likely will impact the pace and timing of an oil price recovery.

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