Oil Recovery to be Slow-Going Process – 2/23/16

Another week, another round of experts saying the oil recovery will be slower than expected.

U.S. oil prices are set to stay near $30 a barrel, down 70% from their peak in June 2014, due to a continued mismatch between supply and demand. High volatility around a low average price are defining the current oil market as global production continues to grow even though inventories are filling to near maximum levels and oil prices are expected to stay below $50 for the rest of 2016.

So far, talks between major oil producers both in and outside OPEC about a freeze in output have resulted in nominal price spikes without any fundamental changes in production.

In an effort to cap the supply of oil to over-saturated markets, Saudi Arabia and Russia reached a preliminary agreement in Doha to freeze output if other states join them. Doubts about the efficacy of the talks still abound since the outcome depends heavily on Iran abandoning its plan to raise production by 1 million barrels a day from sanction-levels as sanctions on the nation’s exports were lifted last month. Though the talks have given some hope to oil producers, most aren’t holding their breath since Russia, Iran, Iraq, and Saudi Arabia make for an incredibly unlikely match up for an agreement that relies on trust and cooperation.

Follow through by each nation is essential for forcing prices higher but conflicting geopolitical goals and governments desperate for revenue stand in the way of a cohesive effort. Recent comments by Iran’s oil minister calling the proposed freeze “ridiculous” sent oil prices sums up the chances of any deal where Iran doesn’t get preferential treatment actually occurring. And if Iran is going to get an exception to the freeze then the planned rise in Iranian output will only balance out declines in US tight oil. A freeze on Iraqi output would conflict with the countries attempts to produce revenues needed for its continued operations against ISIS. The drama involved in just stopping additional barrels from coming to market bodes poorly for an actual cut in production.

The possibility of production cuts following the freeze talks is a pipe dream.

Comments from Iranian officials rejecting a freeze at sanction-level output and from the Saudi Oil Minister rejecting cuts to production on the basis of not trusting other countries to join in, make it clear that it will be the high cost producers, like those in US shale-oil and Canadian oil-sands, who will have to cut back production. Analysts are quick to cite the failure of Russia to live up to a 2008 agreement to curtail supply and its role in backing Syria’s Assad, who Saudi Arabia wants deposed, as reasons why a pact is unlikely. Saudi Arabia is already producing at record rates so a freeze is much less onerous than curbs on output which it sees as subsidizing high cost producers and delaying a re-balancing of markets. Officials have deemed such measures would be counterproductive even if promises from Russia and Iran were taken at face value.

According to the IEA, the oil glut will persist well into 2017 despite large cutbacks for US shale oil production. The adviser attributed the extended period of low prices to the dampening effect of large stockpiles and OPEC policies of defending market share at the expense of reduced revenues. It projected that the shale oil industry will begin expanding again between 2016 and 2021 as drillers lower costs and improve efficiency. It also predicted Iran would replace Iraq as OPECs biggest source of supply growth by 2021. The very real possibility of the glut lasting to the end of 2017 is the last thing cash strapped companies and nations want to hear about but at this point it doesn’t seem like there is any avenue that would bring prices back above $50 anytime soon.

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