Aberdeen Asset Management Investment Strategist, Investment Solutions, Robert Minter comments:
With an OPEC meeting coming this week and oil prices down 60% from their June 2014 levels, you wouldn’t blame an investor for being tempted to take a position that OPEC would announce a cut in production. But that bet would be ignoring the fact that we are in a new regime. OPEC, which has largely controlled middle-eastern oil production since 1960, has switched management styles from a core peak oil supply market to a peak oil demand market. The former peak supply market was characterized by limited oil supply (mostly from the middle east) and unlimited demand (from growing energy use in DM, and a rapidly industrializing EM. While the peak demand regime now sees slowing emerging market growth, lower EM energy density, increased DM renewables and more efficient uses of energy in DM is truncating oil demand growth rates in the medium term. Additionally in the short term the market is assimilating massive amounts of new energy supply in the form of natural gas and light crude which have become technologically accessible in the US. This has reduced US oil imports, displacing those imports back onto the world market. Regardless of your EM growth assumptions, the governments of China and India have taken steps to reduce fossil fuel dependence, and with 140 nations at the Paris Climate Summit this week, there are more to follow.
But could they cut? The Saudis have certainly learned from their production cuts in the 1980’s which only facilitated an increase in their competitor’s market share. This type of cut is even less likely to happen now. The Middle East is a dangerous place and with high unemployment among military age men, quite dynamic as well. The Saudis cannot help but be wary of a rising ‘Great Persian Empire’ consisting of Iran, Iran’s closest ally Syria, Iraq (with Iranian controlled military factions and a large Shia population), as well as Yemen where there are already over 10,000 Saudi led troops battling a militant Shia Houthi group. It is difficult to see Saudi production cuts in order to allow Iran increased market share while the Saudis are in a superior economic position. What would be the effect of an across the board production cut that includes Russia (now producing over 10mm bpd a post-Soviet high)? The first change would be an increase in price, followed by more US shale wells coming online. Estimates are between 800-1500 wells lie ‘Drilled but Uncompleted’ just waiting for slightly higher prices to turn the production taps on and decrease the 7mm bpd that the US still imports.
So what do we expect? Certainly not production cuts, but surely an increase in the rhetoric. It is harmless to reiterate concerns about the long term oil balance, as in the August OPEC bulletin. Perhaps a warning that with the long lead times associated with bringing new oil to market, the industry cannot afford a lapse in spending, without risking a spike in prices to unreasonable levels over the long term. Many economic recessions have been started by rapidly rising oil prices.
For now, however, we continue to slowly work off the excess oil supply generated by the deflationary effects of Quantitative Easing.
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