OPEC: The illusion of victory04 june 2015, 23:20
- On the heels of Saudi Arabia, several countries have decided to increase their production to gain market share;
- The decline in US production is an optical illusion;
- The rise of Iraqi production will accentuate the excess supply in the coming years.
The outcome of the OPEC meeting on June 5th is little doubt. The status quo will prevail. The immediate reaction of the market is, however, uncertain. One can only anticipate high volatility in the coming sessions.
OPEC’s new motto: “every man for himself”
The Arabian Peninsula has decided to engage in regaining market share. This example has been followed by many other countries such as Libya and Iraq.
It is a costly strategy that does not bring satisfaction. Saudi Arabia can count on the safety cushion that represent its foreign exchange reserves, but other countries, like Venezuela, are on the brink of collapse.
The country would already be in default of payment if it did not manage to secure a loan of 5 billion dollars from China earlier this year and did not get 14 billion dollars of investment from Russia last month. The default is still very likely in 2016 because the country barely has money left. Venezuela’s foreign reserves have dropped to their lowest level in nearly 12 years, at 17 billion dollars.
The decline in US output: an optical illusion
The OPEC will certainly pursue its strategy that is, at first glance, successful. The opposition that could exist within the organization at the end of 2014 has disappeared. Algeria has decided to follow the example of Saudi Arabia while Venezuela is in favor of stabilization of oil prices that won’t reach anytime soon the key threshold of 120 dollars per barrel necessary for the country to balance its budget.
The shutdown of numerous drillings for shale oil in the United States is considered by the Arabian Peninsula as proof of the success of its strategy. Yet, it is an indicator that does not allow to fully understand the US shale oil production. Indeed, it does not take into account the rise in productivity as a result of technical progress and the use of horizontal drilling which offers higher profitability than vertical drilling.
In this context, production should continue to increase in the US. The OPEC has only managed to kill shale oil competition from low productivity and poor quality drillings.
Iraq at the corner
Therefore, everything indicates that the imbalance between supply and demand will be a long-term trend. Two new actors will accentuate the excess of supply next year: Iran and Iraq.
It is very likely that an agreement on the nuclear program of Iran will be reached soon. Teheran will be able to increase oil production from 2.8 million barrel per day to 4 million barrel per day. It would amount to only 2/3 of the Iranian oil production from 1973.
However, the main risk is related to the rise of oil production in Iraq. According to the OPEC, Iraq oil output may represent 90% of the expected increase of the organization production by 2020.
Although the capacity of the ISIS to disrupt operations and transportation of oil in the North of the country is real, most of the production remains, for the moment, under the control of the legal government in the Basra region which represents ? of Iraq oil exports.
We don’t expect much change on the ground. The ISIS is not able to expand to the south and, even though this would be the case, there would be an international military intervention to avoid the complete disintegration of Iraq.
OPEC’s strategy does not seem to be able to restore balance to the market. The only way is to have a significant drop in prices towards 35 - 40 dollars at least. It is very unlikely to happen. Our main scenario is based on a barrel between 50 dollars and 70 dollars until mid-2016 and an average oil price of 60 dollars for 2015.