Vulnerability persists in an oil market that might be starting to feel comfortable. The price of West Texas Intermediate crude has gained $10/bbl since the recent low of $45/bbl last December. Oil inventories in the industrialized world fell faster in February than in any month since June 2017, according to the US Energy Information Administration. Worldwide oil demand remains on track for another annual increase.
The market is reclaiming balance. Last year, it anticipated the loss of as much as 1.5 million b/d of supply from the scheduled reinstatement of international sanctions against Iranian oil exports. Prices rose. Production followed. When the sanctions were waived at the last minute, oil gushed into storage, and prices fell. Worry grew about another market collapse.
Target adjustment
But production restraint, coordinated by the Organization of Petroleum Exporting Countries and cooperating exporters since January 2017, held firm. Saudi Arabia and Russia, linchpins of the production agreement, led a target adjustment in December that has accelerated the market’s rebalancing and prevented another round of producer and service-company contraction.
This is the oil market’s vulnerability. The market depends on coordination of supply restraint. So how long can it have what it so obviously needs? The short answer is the easy answer. The oil market will have coordination of supply restraint for as long as Saudi Arabia provides it.
For now, the kingdom seems to see leadership of supply restraint as strongly aligned with its interests. Officials even say they’ll cut oil output as necessary to preserve market balance and the value of crude. For anyone troubled by memories of an unmanaged oil market, this is comforting.
Yet Saudi Arabia, like any nation, changes how it defines and pursues its interests over time. In the second half of 2014, Saudi officials expressed determination to defend market share rather than cut production to support oil prices. By 2016, with the Saudi welfare economy exhausted, they were assembling an international production accord remarkable for durability, flexibility, and effectiveness.
Saudi officials reversed course, too, in 1986, when they grew weary of sacrificing oil production—and, crucially then, associated gas supply—to an agreement largely ignored by other exporters. And they, like any other Gulf decision-makers, will raise production to lower oil prices to weaken an oil-exporting neighbor they come to see as imminently threatening.
Now, however, Saudi motives seem more strongly commercial than military. Ironically, whatever commercial pressures they feel may be eased during the next 5 years by the travails of Venezuela and Iran.
In its new Oil 2019 report, the International Energy Agency points to what normally would mean difficulty for a production-limiting agreement and its leading exporter. The “call” on crude oil from OPEC—what the world needs after oil supply from all other sources—will fall to 30.1 million b/d in 2020 from 31.1 million in 2018, IEA says. It will recover after that as growth in non-OPEC supply, especially from the US, subsides.
By itself, a diminished call would strain supply management, necessitating new sacrifice by producers tempted by rising oil prices to ignore quotas. But IEA projects production losses totaling 1.76 million b/d from sanctions assumed to hit Iran and from Venezuelan economic collapse—more than enough to offset the world’s diminished need for OPEC crude.
A welcome prospect
Supply management might, therefore, continue to accommodate Saudi interests and might, therefore, remain in effect. For producers elsewhere, this prospect is welcome indeed. Producers and service companies go bust in chaotic oil markets. So far, supply management seems to be the only defense against market chaos.
It should escape no one that producers around the world would face big problems over the next 5 years if the right things happened—if Venezuela restored progress to its economic potential and if Iran renounced nuclear development and freed 70 million people from oppressive theocracy. Vulnerability, as most oil producers know, has an annoying way of spoiling comfort.