Crude oil prices are set to react to a short list of widely followed events with a determining effect in 2018, and an increased geopolitical risk will feature high.
In 2017 the focus was on OPEC’s supply management efforts, as investors tested each of the cartel’s announcements against their own market expectations.
OPEC’s conspicuous campaign to reassert its influence over global oil supply has partly borne fruit, although exogenous factors have also played a significant, if not larger role, in unplanned disruptions, in particular. This proves, if anything, that global crude inventories might not be as large as perceived by market participants, especially if a big shock or series of consecutive supply outages were sustained.
Several investment banks have, nonetheless, estimated that the current levels of compliance and market discipline among OPEC and non-OPEC producers have warranted a revision of their respective 2018 Brent forecasts to the upside. Looking at the reality of realised Brent oil prices in 2017, one can see that the consensus toward a bullish price was not so evident one year ago as it is now, even if in most cases, forecasts were at worst a mere $2 off the mark.
Interestingly, a few analysts have voiced doubts about US producers’ ability to effectively produce enough oil (rather than too much) to respond to global growth demand in 2018.
“We … still expect prices to correct significantly in the upcoming weeks”, says Carsten Fritsch from Commerzbank, though the bank has not yet finalised its final projections for 2018.
Most analysts agree that the current prices make shale oil profitable for a larger number of American exploration and production companies. Among the potential drivers of oil prices in 2018, geopolitics is likely to come back to the forefront of market fundamentals.
It is no coincidence that both the Brent and WTI benchmarks have reached their highest levels since late 2014 just as Iran is beset by political upheaval and Venezuela’s oil production is dangerously poised on the edge of bankruptcy.
However, “recent price gains are not backed by fundamentals, but are mainly speculative driven and due to concerns about supply outages”, says Fritsch. The same sort of physical disruptions during a heavy US storm season and a series of continual outages in Libya and Nigeria had only helped the market to tighten faster. The resilience of US shale oil has shown that the global oil market had definitely moved from a world informed by the fear of energy scarcity to energy abundance.
The post optimistic forecasts see US oil production at about 11m bbl/day by the end of the year, even if shale has been, on average, largely unprofitable in 2017. US production takes on average 16 to 20 weeks to respond to a change in a WTI price. The risk of excess US oil growth is bearish and will be actively monitored by investors.
Only a continued, strong capital discipline on the equity market will prevent a potential US oil boom to reboot. In the meantime, the US cannot distance itself from the Middle East, regardless of the supply agreement. Any supply disruption in the Middle East would affect international prices, hence US production.
Any additional supply from US shale would depress global prices and eventually crowd-out the higher-cost producers from the market, giving market share back to the Middle East countries. Besides, the US is far from being energy independent and remains one of the world’s largest importers of oil. The force of things ties American and Saudi interests together.
China demand will be a crucial determinant of global oil prices. Beijing seems keen on pursuing its pollution-curbing efforts, 64% of the country’s energy demand being currently covered by coal.
In 2017, Chinese crude oil increased by 10%, reaching an average 8.4m bbl/day. However, the country’s crude imports exceeded by far its domestic consumption, prompting a surge in refined products exports, to about 6.2m tonnes.
The province of Shandong, which happens to concentrate a number of independent refineries (known as teapots), is set to close nine coal mines in 2018, by government decree. With the first import quotas now released for the teapots, there could be some significant upside for suppliers of medium (in majority, sweet) grades.
The much-awaited Saudi Aramco IPO also features high on the 2018 agenda, although a private sale remains an option. The ambition to float 5% of the giant Saudi state-owned company – whose proven reserves are estimated at about 260bn bbl – will not only raise cash to help the kingdom develop entirely new sectors and sever its dependency on oil, but also smooth the relationship with international investors and facilitate the country’s wider political reforms.
Last, OPEC’s exit strategy will be actively watched by market participants, as winding down the supply management efforts may give producers enough room to put back 1.8m bbl/day of oil onto global markets. This, by all means, would be the worst-case scenario.