The announced cuts by Opec are not long enough
to launch a bull market, say experts.
Opec production cut: Genuine boon or flash in the pan?
DUBAI, February 7, 2017
By Muqsit Ashraf and Manas Satapathy
Will announced cuts in crude production launch an upcycle such as those seen in the 1970s and early 2000s? Or, will the market more closely resemble the lagging prices of the mid-‘80s through the turn of the century? Experts weigh facts and figures.
For roughly 24 months, supply has exceeded demand by 1 to 1.5 million barrels per day (bpd), boosting inventory to nearly 3.0 billion barrels globally. Assuming a third of the inventory is non-strategic, one billion barrels could absorb a supply shortage of one million bpd for over 30 months.
Last year's capital expenditures dropped under $400 billion (versus $654 billion in 2014), which would have had a greater impact on driving down excess supply had oil prices stayed low. With oil prices above $50, however, capex is projected to grow, particularly in North America, West Africa and South America.
The announced cuts by Opec are likely to make a difference, but not enough, or for long enough, to launch a bull market. Three reasons:
Slippage: Opec countries are known to not adhere to the contractual terms. Overproduction historically has ranged from 0.6 to 1.9 million bpd. Combined with the headroom for Iran of 0.3-0.4 million bpd, this is expected to be at least 0.4 million bpd3. If anything, the incentive to produce more than allowed will be higher to take advantage of higher prices while they last.
Light tight oil (LTO) production: Low prices, reduced capacity and a run-up in supply chain costs constrained LTO in the United States. But consider the massive reserves in the Permian basin, a large inventory [4,500] of drilled uncompleted wells, and renewed investments demonstrated by rising acreage prices. Net result? LTO production in 12 months is likely to exceed the peak of 20154.
Price elasticity: Demand reductions typically lag rising prices. Along with rising demand due to lower crude prices, however, we expect a decrease in demand, estimated at 0.1 mil bpd, due to higher prices5.
Without deeper cuts from Opec and non-Opec players, the supply glut is likely to re-emerge in the second half of 2017.
Are happier times a distant dream? Not quite. As in other markets, supply and demand forces will play out. Players will have to adjust to volatility and restrained prices. Winners will be rigorous in developing assets that are economically superior and better suited to their internal capabilities. They also will be agile in aligning capital spend with market cycles, and be more inclined to invest in projects with a front-loaded (or lower-risk) cash flow profile.
Muqsit Ashraf is managing director for Energy within Accenture Strategy. Manas Satapathy is a managing director in Accenture’s energy practice.