By John Richardson
HERE are first of all the facts from the latest International Energy Agency (IEA) report:
- OPEC production hit a record high in September of 33.64m bbl/day. Iraq produced more oil than ever, while Libya reopened oil ports.
- Further boosting global supply levels is the fact that production in non-OPEC member Russia hit a post-Soviet record.
- While supply is running high, the IEA said demand is slowing along with the global economy – a combination that could pressure oil prices. The IEA forecast that the market will remain oversupplied through mid-2017 if OPEC doesn’t enact last month’s pledge in Algeria to cut supply to between 32.5-33m bbl/day.
And on the late September meeting in Algeria, when OPEC producers agreed a very modest cut in production, the Paris-based IEA added this:
Now the real work starts. Apart from setting a supply target of between 32.5 mb/d and 33 mb/d, other critical details – like individual country allocations, production baseline and implementation date – need to be finalised when OPEC meets on 30 November. Iran, Libya and Nigeria – all aiming to raise output – are said to be exempt from cuts. A significant rebound in supply from Libya and Nigeria and further growth from Iran would suggest that bigger cuts would have to be made by others, such as Saudi Arabia, to meet the new output target.
As for US shale-oil production, which of course falls outside OPEC, we have known since 2007 that production efficiencies have been rising – meaning ever-lower breakeven production costs, thanks to US-based Energy Information Administration analysis.
This is explains why, even before the oil-price rally of the last few weeks, Goldman Sachs was estimating a 600,000-700,000 bbl/day rise in US production by the end of 2017..
The ability of US producers to use financial-market hedging to lock-in their profits when oil prices rise has also been long understood.
Sure enough, therefore, since this latest oil market rally began short hedges, primarily taken out by crude producers, have increased to 592m/bbl, which is nearly their highest level since May 2011 when crude futures prices were $106/bbl.
The US shale oil industry is thus, thanks to this hedging, already in a much-stronger position to raise production, even if crude prices were to crater again.
The Chase For Yield
But we are moving towards a post-fact world where facts are becoming less and less important. What instead matters is that the financial sector can sell a story for long enough to enable it to make money by getting in and then out of the crude market at exactly the right time.
So they used the Algerian deal to drive prices higher, and then on Monday used comments attributed to Vladimir Putin about Russia being keen to cut production as a means of adding further momentum to the rally.
This was despite, as I said, the Algerian deal being in fact no deal at all. It was only agreement, as the IEA pointed out, to discuss a very moderate cut in production at the next formal OPEC meeting on 30 November.
The comments attributed to Russia’s president also of course did not amount to a firm commitment to cut production.
And only shortly afterwards, Igor Sechin, president of Russian oil producer Rosneft was reported to have ruled his company out of taking part in any OPEC production cut – or even a freeze in production at today’s record-high levels.
It has long been the case that financial markets heavily influence the direction of oil prices. But as fellow blogger Paul Hodges will detail in a post later today, trading in the WTI futures contract has so far this year risen to 10 times physical volumes – an all-time high.
This is why I say we are moving towards an entirely post-fact world in crude markets where the facts are becoming less and less important (in politics, as I shall discuss on Friday, we are sadly already in a post-fact world).
The oil market started shifting away from reality immediately after the Global Financial Crisis, when the US Federal Reserve triggered an avalanche of cheap money.
Pension funds and hedge funds could thus no longer afford to leave their money in the bank or in US Treasuries, as this would have left them with negative returns.
They instead started chasing yield in commodities and equities etc. regardless of the long-term supply and demand fundamentals.
As I said, the only thing that has really mattered since then has been the ability to sell a story, however spurious, for long enough to make money from a rally or dip in crude prices.
The Risks Ahead
It seems highly unlikely that OPEC can reach a deal on 30 November to make a production cut sufficient to dent today’s oversupply of oil.
Even if such a cut did happen, we know that this would be counterproductive as it would enable the US shale-oil industry to quickly gain more market share. As I have described above, this is already happening.
But this doesn’t of course mean that oil prices would necessarily retreat if no deal is reached on 30 November.
What instead might happen is that another story emerges that drives prices even higher, enabling the financial world to make more money in its search for yield, given that it now looks as if the US Federal Reserve will keep interest rates lower for longer than just anybody had expected at the start of this year.
The chemicals industry must plan for a point in time when the US Fed and other central banks stop printing money and start raising interest rates.
It must in parallel prepare for another macroeconomic shock that causes a retreat in commodity markets in general, and in equities, regardless of central bank monetary policy.
In late 2014 the shock was the belated realisation that the Chinese economic miracle wasn’t a miracle at all, but was instead a deeply-flawed investment-led growth model.
A global trade war in 2017 remains top of my list for future shocks on the same scale as the slowdown in China.