OPEC spare capacity set to reach levels last seen in the depths of the financial crisis in 2009, analysts say
One piece of the jigsaw puzzle is missing to complete the deflation landscape across the West: a slide in oil prices. This is becoming more likely each month.
Turmoil across the Middle East and parts of Africa has choked supply over the past two years, keeping Brent crude near $110 a barrel despite a broader commodity slump. Cotton and corn prices have halved, as has the UBS index of industrial metals. Such anomalies rarely last.
“We estimate that crude oil is now the mostly richly priced commodity in the world,” says Deutsche Bank in a fresh report.
Michael Lewis, the bank’s commodity strategist, said markets face an “new oil supply glut” as three forces combine. US shale will add 1m barrels a day (b/d) to global supply for the third year running; Libya will crank up shipments after a near collapse in 2013; and Iran will come out of hibernation. “This will push OPEC spare capacity to levels last seen in the depths of the financial crisis in 2009,” he said.
America is on track to overtake Saudi Arabia as the top global producer of oil by 2016. It will account for more than half of non-OPEC world supply this year. The US Energy Department says US oil imports will drop to 5.5m b/d by next year, half the level a decade ago. This turns the world’s 89m b/d market upside-down.
Deutsche Bank said Saudi Arabia may have to slash its output by a quarter to 7.5m b/d this year to stop the bottom falling out of the market. The Saudis no longer have such money to spare. They are propping up an elephantine welfare nexus to keep a lid on explosive tensions in the Eastern Province, home to Saudi oil and its aggrieved Shia minority. A cut of this size would push the budget into deep deficit.
This comes as Iran makes its peace with the West. Its 30-year vendetta with US – Iran’s natural ally in many ways – no longer makes sense. President Hassan Rohani is no doubt pushing his luck by describing the nuclear deal as a “surrender” to Iran by the great powers, but let him have his flourish to save face. “It does not matter what they say, it matters what they do,” retorted the White House.
The facts are that Mr Rohani has agreed to eliminate Iran’s stocks of 20pc enriched uranium. Iran will submit to daily inspections of its Fordo enrichment site and monthly inspections of the Arak reactor. The deal is on track and the first phase will come into force next week.
The UN oil sanctions have been crippling. They reduced the economy to rubble last year. The real is almost worthless. Mr Rohani is desperate to break out of the impasse. The US, in turn, is carrying out a “Kissingeresque” pirouette in its Middle East policy. President Barack Obama says he will veto any attempt by Congress to scupper the accord.
Julian Jessop, from Capital Economics, says the existing sanctions cut Iranian supplies of oil by 1m to 1.5m b/d. In the end they would have knocked out up to 3m b/d in various ways. This will start to come onto the market instead as the sanctions are softened.
Meanwhile, Libya is picking itself up from the floor after separatist militia forces reduced the country to anarchy last year, blockading key export terminals. The oil minister said this week that crude output has tripled since the summer to more than 600,000 b/d as the El Sharara field comes back on stream. Libya may add 1m b/d to global supply this year.
Bank of America says a simultaneous return of Iran and Libya could add up to 3m b/d. Just a third of this “positive supply shock” could shave $20 off the world oil price, unless OPEC’s fractious cartel can slash output quickly enough to offset it. We should expect hot words at OPEC summits, and plenty of cheating.
It is hazardous to make any assumptions about Mid-East politics, not least with the Shia-Sunni conflict spreading from Iraq and Syria to threaten the whole region in what looks disturbingly like the onset of the Catholic-Lutheran showdown in Europe’s Thirty Years War – a blood-letting that ended only with mutual exhaustion and bankruptcy at the Treaty of Westphalia in 1648.
The uprising by Sunnis in the Iraqi region of Anbar has revived fears of a full-blown civil war. The Islamic State of Iraq and Syria has seized control of Fallujah and Ramadi. Iraqi oil output has crashed to 2m b/d as Al Qaeda attacks the Kirkuk-Ceyhan pipeline. The United Nations said 8,868 people were killed last year in Iraq, nearly all civilians.
Iraq is clearly a long way from becoming a 6m b/d petro-superpower by the end of the decade, as predicted by the International Energy Agency last year. Yet the latest turmoil cuts both ways for oil prices. Any calming of tensions could lead to a rapid rebound in output. Indeed, HSBC expects Iraqi and Kurdish production to rise to 3.5m b/d by the end of the year despite the conflict.
Oil bulls says global economic recovery is strong enough to soak up any rise in supply. Perhaps, but Simon Ward at Henderson Global Investors says the world money supply rolled over in November and is now flashing amber warnings.
His key gauge – real six-month M1 – for the G7 rich states and E7 emerging market economies has slowed to 2.3pc from 3.7pc last May. It acts as an early warning indicator, six months ahead. This suggest that global growth may soon fade. “Global risks are rising. The cycle already looks mature by historical standards,” he said.
The growth of broad M3 money in the US has slowed to 4.6pc even before Fed tapering cuts off stimulus. In the eurozone it is has been near zero for the past six months.
The latest data from China are very weak, with M2 growth falling to 13.6pc in December from 14.2pc in November as the authorities tighten. It is the change in pace that matters. China looks eerily like the US in 2007 when broad money buckled.