Lost in Texas’s Snowstorm, What Can Kill This Oil Surge?
(Bloomberg Opinion) -- The snowstorm that slammed Texas and neighboring states last week is just the latest in a series of factors that have sent oil prices soaring. It risks burying visibility of the one thing that might undo the rally — a huge reservoir of idle production capacity.
Oil prices began to move lower on Friday, but they are still close to their highest level in over a year, since well before the pandemic trashed global demand. A bull run took Brent from around $37.50 a barrel at the end of October to nearly $62.50 in the space of 15 weeks, a rise of 4% per week. Then the freak snowstorm added another couple of bucks.
The pressures behind the steady climb are well known: recovering economies, vaccine rollouts and, less often acknowledged, the huge supply cuts adhered to with unprecedented discipline among the oil producers of the Organization of Petroleum Exporting Countries and their allies in the wider OPEC+ group, which came on top of price-related slumps in production elsewhere.
Oil demand has started to recover and is expected to return even more quickly in the months ahead. The International Energy Agency sees it within 1.5 million barrels a day of pre-pandemic levels by the end of this year, compared with a 16 million-barrel deficit in the second quarter of 2020. But there are still constraints on supply, and that’s helping to drain excess stockpiles and support prices.
In the U.S., newfound capital discipline among producers in the shale patch has seen them take a much more cautious approach to new investment, at least until now. That has kept a lid on production levels even as prices started soaring. It’s a similar picture in many places around the world. Field maintenance projects and capital investments have been shelved, undermining potential new flows and hastening decline rates at existing fields.
Even within OPEC, Angola and Algeria have both seen their production capacities slump to the point where they’re no longer able to meet their reduced target for output levels, let alone their pre-cut baselines. Angola’s production was more than 80,000 barrels a day below its goal in December and the gap is getting wider every month.
But elsewhere in the group it's different. Ten OPEC+ countries hold about 7.75 million barrels a day of spare capacity. Even excluding Saudi Arabia, the champion for full compliance with output cuts and the most wary of easing up too quickly, that slack is still close to 5.25 million barrels. That’s more than enough to upend the price rally. And it doesn't take into account anything that may come from Iran.
With that as a stark backdrop, the OPEC+ alliance is scheduled to meet in less than two weeks to decide whether to adjust its agreed output targets in April. Saudi Arabia is already due to end its voluntary additional cut that’s in place for February and March, which would add back 1 million barrels a day of production.
With Brent close to $65 a barrel, the appetite among other members for maintaining deep cuts may be waning.
The most optimistic of the forecasts from the major agencies (the IEA, U.S. Energy Information Administration and OPEC) sees global stockpiles coming down at an average rate of 2 million barrels a day this year, if OPEC+ sticks to its current output target — which it won't.
Outside of Saudi Arabia, most of the group’s spare capacity is held in just three countries: the United Arab Emirates, Russia and Iraq. The UAE is already chafing under an output target it believes is too low. Russia demanded (and got) consensus-busting output target increases for February and March when the full group met last month. It and Kazakhstan were the only countries not to see their targets frozen. Iraq has consistently failed to cut as much as it should have and has consistently failed to make up for past over-production.
If output-cut fatigue grows, things could get very ugly, very fast.
As it stands, the revised OPEC+ deal would allow the group to add up to half-a-million barrels a day in April, but Russia has already had its share of that in February and March, and so it should get nothing more. I doubt Moscow, already diverting crude from export terminals to local refineries, would be happy with that.
With Brent crude testing $65 a barrel, even as the impact of the Texas snowstorm is receding from the oil patch (although its effect on refineries looks set to last much longer), other alliance members may join Russia in questioning the wisdom of continuing to hold so much production off the market to the inevitable benefit of producers elsewhere. Customers such as India are starting to protest too, which will only add to the pressure.
If Saudi Arabia can’t manage all that in a controlled way, its erstwhile allies may simply open the taps. They’ve been there before and it wasn’t pretty.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Julian Lee is an oil strategist for Bloomberg. Previously he worked as a senior analyst at the Centre for Global Energy Studies.
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