After a seven-hour session in Vienna on 4 December, the only agreement Opec members reached was to meet again in June next year. It was a measure of how deep the divisions ran that the cartel could not even agree on a cap for oil production. Markets wasted no time in expressing concern over both the inconclusive meeting and the threat of oversupply. Benchmark oil prices plunged in the first and second weeks of December (to $38 for WTI and below $41 for Brent crude) on the back of Opec’s decision to maintain its current production level of 31.5m barrels per day.
For the time being, the lack of agreement effectively suspends the ceiling on Opec production, and the cartel will wait until the next meeting to confirm its output target. This shows that Opec is determined to legitimise its right to produce at current levels or above, and compete for market share.
The most important consideration for Opec is Iran’s determination to ramp up its production to levels near 1m barrels a day after sanctions are lifted, which would represent an increase of about 1 per cent in world supply. The sanctions are expected to be lifted in the first quarter of 2016. It is not probable that Saudi Arabia and other members will reduce their own output levels to accommodate Iran’s increase in the total output. It is much more likely, given budget pressures on many Opec countries and the lack of Saudi-Iranian co-operation, that all member countries will continue producing as much as they please, in excess of a total 31.5m barrels per day.
It has been quite clear for some time that Opec strategy has been to compete for market share and to place the burden of being the swing producer on someone else. This strategy has worked, as it is US oil producers that have had to shoulder the burden, close rigs and reduce production. Drilling activity is already dropping off due to low prices – not only in the US, but also in other non-Opec countries such as Russia and Mexico.
So what does this mean for the oil price next year? Without doubt, December’s disorderly decline in the cartel’s cohesion has moved oil price forecasts downwards – and the potential timing of a pick-up further back. As long as oil production is outpacing oil consumption, a glut in inventories will mean oil prices should remain low and range-bound through 2016. For now, the build-up of inventories continues, because even though US production is starting to decrease,with rig counts falling by 65 per cent in a year, there are no signs of Opec’s production declining.
Looking beyond the near term, this year’s low oil price has resulted in cuts to capital expenditure at US energy companies, which means under-investment could cause production challenges in the future. Indeed, the US Energy Information Agency estimates that US crude oil production will decline to 8.8m barrels per day in 2016 from the 9.3m barrels per day recorded this summer. If this reduction in US output is accompanied by a decline in production across the world, this could result in a more balanced market over time. The EIA predicts oil prices to rise towards $51 for WTI barrel towards the end of 2016. But Opec does not seem ready for that just yet.
For investors, the implications of Opec’s family squabble are mixed. Energy companies, particularly in the US, continue to look unattractive for both equity and high yield investors. On the flipside, companies for which crude represents an input cost – global industrials, plastics manufacturers, transport companies – stand to benefit. The recent Opec news is also another reason for the consumer to be positive, particularly in the oil-guzzling US, where cheap prices at the pump will mean more scope to spend.
Nandini Ramakrishnan is a global market strategist of JP Morgan Asset Management