Will the oil mar­ket con­tinue to drown in over­sup­ply?

The Pak Banker - - OPINION - Van­dana Hari

IM­MI­NENT new sup­ply from Iran and wor­ries over a slow­ing China and its pos­si­ble con­ta­gion ef­fect sucked crude into a vor­tex right off the bat as trad­ing be­gan in 2016. Bench­mark Brent fu­tures brushed past 12-year lows below the $30/bar­rel mark in the third week of Jan­uary, prompt­ing some to call for a $10 bot­tom.

To­wards the end of the month, state­ments from Rus­sia that it was plan­ning to meet with the Saudis and other Opec mem­bers in Fe­bru­ary to dis­cuss co­or­di­nated ef­forts to lower pro­duc­tion shored up sen­ti­ment, push­ing crude more than 20% above the month's low. But any up­swing in a volatile mar­ket grap­pling with un­cer­tain­ties risks be­ing wiped out the next mo­ment. That would be es­pe­cially true in view of the com­plex­i­ties in­volved in an Opec-non-Opec at­tempt to co­op­er­ate on an out­put cut.

The re­cent rise in political ten­sion be­tween fel­low Opec mem­bers Saudi Ara­bia and Iran, com­bined with the fact that a sanc­tions-free Tehran is all geared up to bring up to 1 mil­lion bar­rels per day (b/d) of ad­di­tional crude into the mar­ket, makes an agree­ment within the pro­ducer group to rein in out­put seem ex­tremely re­mote, let alone col­lab­o­rat­ing out­side. In fact, Opec's se­cond largest pro­ducer Iraq, which hit record high pro­duc­tion in 2015, hopes to boost out­put by an­other 200300,000 b/d above cur­rent lev­els to reach 4 mil­lion b/d this year.

Iran's oil min­istry, mean­while, ac­ti­vated its planned 500,000 b/d oil out­put in­crease 17 Jan­uary. If achieved, this vol­ume would take Ira­nian out­put to around 3.39 mil­lion b/d and ex­ports to 1.5 mil­lion b/d. The im­me­di­ate im­pact on ex­ports is ex­pected to come from Iran's con­sid­er­able float­ing stor­age, which holds 47-49 mil­lion bar­rels of crude and con­den­sate, ac­cord­ing to Platts cFlow data.

"Un­less some­thing changes, the oil mar­ket could drown in over­sup­ply," the In­ter­na­tional En­ergy Agency warned in its Jan­uary re­port, es­ti­mat­ing an over­sup­ply of 1.5 mil­lion b/d in the first half of 2016 if Iran adds 600,000 b/d by mid-year. Opec struck a more op­ti­mistic note in its monthly re­port, say­ing 2016 would see the start of the re­bal­anc­ing process as deep capex cuts start to feed through to non-Opec sup­ply. Out­put in Canada-where all projects are now below cash cost-the North Sea, Latin Amer­ica and some parts of Asia are par­tic­u­larly vul­ner­a­ble, it said.

The col­lapse in oil prices to below $30 was "ir­ra­tional," chair­man of state-owned oil gi­ant Saudi Aramco told the World Eco­nomic Fo­rum in Davos on 21 Jan­uary, as­sert­ing that the mar­ket had over­shot on the low side and would inevitably start turn­ing up, given that many small pro­duc­ers were fac­ing fi­nan­cial dif­fi­cul­ties. Days ear­lier, Saudi Ara­bia had flagged what many re­garded as the un­think­able-the po­ten­tial sale of a part of Aramco, the King­dom's crown jewel. On the de­mand side, the av­er­age of lat­est fore­casts by the IEA, Opec and the US En­ergy In­for­ma­tion Ad­min­is­tra­tion point to ex­pec­ta­tions of con­sump­tion grow­ing by about 1.3 mil­lion b/d in 2016 ver­sus last year, com­pared with an es­ti­mated 1.52 mil­lion b/d rise in 2015.

But the oil mar­ket may not be buy­ing the growth story, still rat­tled by the spate of weak man­u­fac­tur­ing and GDP growth data from China, which had wiped off more than $3 tril­lion from the global equity mar­kets within the first two weeks of the year alone.

Bei­jing re­ported the slow­est real GDP growth in 25 years in 2015 at 6.9%, but more wor­ry­ingly for the pro­duc­ers of raw ma­te­ri­als, China's en­ergy in­ten­sity seems to be de­clin­ing even more rapidly. Oil de­mand in the world's se­cond largest econ­omy and also the se­cond largest con­sumer is ex­pected to rise by just about 2.5% from a year ago in 2016, ac­cord­ing to Platts China Oil An­a­lyt­ics, com­pared with 5.8% growth in 2015.

In the US, the world's largest oil con­sumer, a re­lent­less rise in oil stock­piles and con­tract­ing de­mand fur­ther fu­eled the mar­ket's neg­a­tive sen­ti­ment. Com­mer­cial crude stocks in the US at 494.92 mil­lion bar­rels in the week ended 22 Jan­uary were the high­est on record and nearly 30% above a year ago. Mean­while, av­er­age four-week prod­uct de­mand was down 1.7% year on year. With the oil price bot­tom still nowhere in sight, pro­duc­ers around the globe are hun­ker­ing down for pro­longed pain. Oil-rich gov­ern­ments across West Asia are slash­ing pub­lic spend­ing, bor­row­ing money, rais­ing taxes, and re­mov­ing sub­si­dies. The Rus­sian rou­ble hit his­toric lows against the dol­lar in Jan­uary, while Venezuela is pre­dicted to suf­fer the worst re­ces­sion on the globe in 2016. Con­tin­ued blood-let­ting in the cor­po­rate world will see fur­ther job and up­stream capex cuts at oil and gas pro­duc­ers and ser­vice providers.

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