The only way is up as oil prices start to stir

The Sunday Telegraph - Money & Business - - Business - LIAM HALLIGAN Fol­low Liam on Twitter @liamhal­li­gan

Oil prices are stir­ring again. Brent crude last week topped $68 a bar­rel for the first time since 2015 – and shows few signs of abat­ing. Oil has now risen no less than 140pc since bot­tom­ing out in Jan­uary 2016 and is up 35pc over the last six months.

Dur­ing 2018, the path of crude will con­tinue to re­flect the on­go­ing “Opec ver­sus shale” bat­tle. As such, the mighty ex­porters’ car­tel will try to keep prices high by lim­it­ing pro­duc­tion. The gung-ho US shale in­dus­try, mean­while, com­pris­ing in­de­pen­dent and of­ten heav­i­lyin­debted pro­duc­ers, will do all it can to pump as much as pos­si­ble – which pushes prices down.

At the same time, numer­ous other geo-po­lit­i­cal ten­sions will swirl. Will Rus­sia keep help­ing Opec by lim­it­ing pro­duc­tion? Will ten­sions across the Mid­dle East spi­ral out of con­trol? Eco­nomic text­books tell us prices are de­ter­mined by sup­ply and de­mand, based on com­mer­cial de­ci­sions by “ra­tio­nal agents”. The price of oil, per­haps the world’s most cru­cial sin­gle eco­nomic vari­able, isn’t like that. Crude is driven largely by pol­i­tics – and 2018 will be no dif­fer­ent.

Last week’s three-year oil price high is a case in point. Crude surged after demon­stra­tions be­gan in Mash­had, Iran’s sec­ond largest city, be­fore spread­ing to other parts of the coun­try, in­clud­ing the cap­i­tal Tehran. Since se­cur­ing a his­toric sanc­tions-lift­ing deal with six world pow­ers in 2015, Iran has re­stored oil pro­duc­tion to 4 mil­lion bar­rels a day (a hefty 4.2pc of global pro­duc­tion).

Mar­kets are spooked less by con­cerns that Ira­nian demon­stra­tors will threaten the coun­try’s oil in­dus­try di­rectly. The fear is that a heavy­handed crack­down on pro­test­ers by the Ira­nian au­thor­i­ties will give Pres­i­dent Trump the ex­cuse he craves to re-im­pose sanc­tions, re­mov­ing Ira­nian crude from global mar­kets once more. Trump has never liked Obama’s Iran rap­proche­ment and is itch­ing to re­verse it – a move that could send oil prices soar­ing.

At least part of the re­cent price rise does re­flect eco­nom­ics. As the global re­cov­ery takes hold, oil de­mand has been ris­ing. Since 2012, crude con­sump­tion has ex­panded sharply, from 90.6 mil­lion bar­rels daily to al­most 97 mil­lion – a 7pc rise – and we’re now in the midst of the strong­est pe­riod of oil de­mand growth since the 2008 global fi­nan­cial cri­sis. With the IMF fore­cast­ing 2018 global GDP growth at a chunky 3.6pc, and the Chi­nese govern­ment stock­pil­ing oil with gusto, that bullish case for crude is tak­ing hold.

Opec, which still con­trols around 40pc of global pro­duc­tion, has ev­ery in­cen­tive to main­tain cur­rent sup­ply lim­its. The al­liance the car­tel struck last Jan­uary with non-mem­ber Rus­sia, has re­moved al­most 2 mil­lion bar­rels from global mar­kets daily, soak­ing up pre­vi­ously bloated in­ven­to­ries. In late Novem­ber, that deal was ex­tended through 2018, though it will be re­viewed at the Opec sum­mit in June.

The car­tel’s king­pin, Saudi Ara­bia, clearly wants a con­tin­u­a­tion. The Desert King­dom is now so cash­strapped that it is selling part of oil gi­ant Saudi Aramco – the flota­tion price of which will be driven by pre­vail­ing crude prices. It’s not

en­tirely clear, though, that Rus­sia wants to ex­tend the deal. Once crude goes above $60, that en­cour­ages US shale pro­duc­ers to an ex­tent that goes be­yond Rus­sia’s long-term in­ter­ests.

The Saudis, fac­ing po­lit­i­cal dis­sent at home and with a bud­get deficit that’s still around 10pc of GDP, need cash now – which is why Riyadh wants higher prices. The Rus­sian govern­ment, in con­trast, de­spite much of what you read, has an ex­tremely strong bal­ance sheet. Moscow’s re­serves now ex­ceed $500bn, up some 20pc over the last two years. The Rus­sian bud­get, mean­while, as­sumes $40 oil – so there is plenty of fis­cal head­room.

What re­ally mo­ti­vates Moscow, rather than short-term cash, is long-term mar­ket share – as shown by grow­ing ex­ports to China. Rus­sia last week opened an ex­ten­sion to the East Siberia-pa­cific Ocean, or ESPO, oil pipe­line to China. This ce­ments Moscow’s sta­tus as the lead­ing crude sup­plier to its mas­sive Asian neigh­bour, dou­bling ex­port ca­pac­ity to 220 mil­lion bar­rels a year. Saudi wants to main­tain pro­duc­tion con­straints, but Rus­sia may not agree.

As for the US shale pro­duc­ers, higher prices will of course give them ac­cess to more ven­ture cap­i­tal, en­cour­ag­ing them to pump like billy-o. The ex­ploita­tion of “tight oil” fields in Texas, North Dakota and the Ap­palachi­ans has pushed US oil out­put from 6.8 mil­lion bar­rels daily in 2006 to 12.4 mil­lion last year. The growth of Amer­ica’s “non-con­ven­tional” oil pro­duc­tion, which I ini­tially un­der­es­ti­mated, has been truly spec­tac­u­lar.

The US, which con­sumes 20m bar­rels daily, re­mains mas­sively de­pen­dent on oil im­ports, of course. Shale hasn’t solved Wash­ing­ton’s geo-po­lit­i­cal headaches. But the ex­pan­sion of Amer­i­can oil pro­duc­tion over the last decade is a heady story of in­ge­nu­ity and com­mer­cial grit. The US En­ergy In­for­ma­tion Ad­min­is­tra­tion is al­ready fore­cast­ing do­mes­tic shale out­put will rise by 780,000 bar­rels a day this year, more than dou­ble the 2017 in­crease.

Much has been writ­ten about elec­tric cars and “the end of the oil era”. That won’t hap­pen any­time soon. The global oil com­plex and the man­u­fac­tur­ers of in­ter­nal com­bus­tion en­gines, are two of the most pow­er­ful lob­bies on earth. Oil de­mand will keep ris­ing for years and prob­a­bly decades hence. Those bet­ting against this oil rally, though, hope that as the US shale pro­duc­ers up the ante, the re­cent Rus­sia-opec love-in will cease. But that sce­nario would be in­stantly de­mol­ished if Trump wakes up to­mor­row and launches a nasty tweet against Iran. Eco­nom­ics is rarely bor­ing. Not least when pol­i­tics pre­vails.

‘Crude is driven largely by pol­i­tics – and 2018 will be no dif­fer­ent’

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