Higher Oil Prices Are Coming in 2016
Last week, the Organization of the Petroleum Exporting Countries (OPEC) sent a clear message that it does not intend to alter its strategy from the past 12 months. OPEC will keep producing oil at its highest possible output in order to discourage—if not outright eliminate—producers with the highest costs. Syria is one of the keys to understanding the course of Saudi Arabia’s oil price policy and given the kingdom’s influence in the organization, Saudi policy is OPEC policy.
The conflicting plans for Syria pursued by those in the Russian-Iranian current, favoring the reestablishment of President Assad’s power before any transition can be considered, and the U.S.-Saudi policy of forcing Assad out of office are key to understanding the course of oil prices. Geopolitics is still central to the oil market.
The geopolitical scenario is such that prices could rise in the second half of 2016 in response to global demand, which is expected to increase, given the growth-stimulating policies. By 2017, the oil supply should be on the decline. The reason is simple: current oil prices have made it virtually impossible to develop new oil projects or improve existing ones.
$70 Oil? It’s Possible
For the next few months, the price will be presumably still low, but in the medium- and longer-term, if not already, producers will not be making sufficient income to address demand. Only a crystal ball has the answer to where oil prices might go, but current prices of $37.00 per barrel were last seen in 2009. They rose to above $100.00 after and they were at over $100.00 in 2007. Therefore, a spike back up to at least $70.00 in 2016 is likely more than just possible.
Chart courtesy of www.StockCharts.com
OPEC’s strategy to flood the market with oil to maintain low oil prices has a shelf life; it cannot last as long as needed to shut all competitors out of the market. The shale market is certainly under pressure, such that production in the U.S. has dropped. (Source: “Oil’s drop below $38 may cause a world of hurt for U.S. shale,” Market Watch, December 7, 2015.) Saudi Arabia and Iraq, both OPEC members, are at the limits of their thresholds. Therefore, for 2016, the market should not expect any output increases from these countries.
Iran is the key factor; it might be the only one able to increase production at a level substantial enough to have an impact, given the repeal of sanctions. Iran is also an OPEC member and needs oil revenues to help internal development. It cannot afford the low prices, so just because it can flood the market, that doesn’t mean it will.
For 2016, the International Energy Agency (IEA) has forecast further demand of 1.4 million barrels per day, which would imply an absorption of the excess oil supply over the next 12 months. (Source: “IEA: Oil Demand to Slow Through 2016,” Fortune, November 13, 2015.) In 2017, the reduced supply in North America from lower shale investment might actually create an oil deficit to the point where shale oil would be called on to address a starving oil market!
Such developments offer opportunities to investors, many of whom have likely been discouraged by oil prices into going heavily underweight in the energy sector. Those shale producers able to keep growing at prices significantly lower than the $70.00-per-barrel shale threshold will be the first to benefit. Meanwhile, the oil majors, especially Exxon, will be focused on ensuring dividends, while keeping constant production volumes. At current prices, this is very difficult to achieve.
Bullish Geopolitical Winds
Syria’s president Assad and the so-called opposition (essentially all groups fighting the Assad government with the exception of ISIS) have offered conciliatory words. Assad said he is ready to negotiate with the opposition, even if he deliberately excluded armed groups from the definition of “opposition.” His statement coincided with an announcement from the main political and military factions of the Syrian opposition gathered in Saudi Arabia, in favor of negotiations with representatives of the regime in Damascus under UN mediation.
The opposition, perhaps for the first time since the start of the conflict, hinted that it would agree to participate in future negotiations to seek a political solution to the conflict that began in March 2011. The deal is not done yet, as Assad is concerned that some of the groups involved in the opposition are among those it and Russia consider terrorists. Nevertheless, the geopolitical climate may yet hold some placatory winds.
The United States, Russia, and the UN will be discussing Syria in more constructive terms at the next meeting of the International Support Group for Syria. Traditionally, geopolitical tensions in the Middle East have led to higher oil prices. Now, given the rivalry of Russia and Saudi Arabia in respectively supporting and opposing the Assad government, oil prices need peace or the promise of peace to rise.
The Bottom Line on Oil Prices
Saudi Arabia has blasted OPEC and quotas to knock out Iran and Russia, even as it also wants to eliminate American shale. Saudi Arabia also hopes to curb Iran’s splash into the market, given that it is the only producer that can threaten its hegemony in the Gulf. The Saudis are paying a high price, having burned through several billions of dollars just to maintain their OPEC leadership and oil market hegemony.