Many of the biggest themes of 2023 will come to a head this year, but beware both naysayers and apologists
Last year was supposed to be the year of the new normal. Instead, there remains huge uncertainty over the global economic outlook, OPEC’s unity, geopolitical tensions and the energy strategies of both IOCs and NOCs. But the oil industry must navigate not only vastly opposing market forces but also the competing agendas of bullish and bearish narratives.
This raises the question of where those with vested interests should put their trust. Even apparently independent commentators must be assessed for their biases, especially when there are headlines to be written and money to be made, and when the way ahead is unclear. Is $80/bl a sweet spot? An oil producer’s bare minimum level? A pain point for consumers? Is a balanced market rooted in hard data or is it an ethereal concept analysts use to argue a point? It certainly seems the kind of line OPEC+ wants to defend, but for how long and under what duress will those conditions hold? The answer lies in this oxymoron: stability around the $80/bl mark has never looked so fragile.
Watch out for shale boom headlines. There has been much excitement around US oil production hitting record highs beyond 13m b/d on greater efficiency gains and higher prices. This has been compounded by the ExxonMobil/Pioneer and Chevron/Hess megamerger deals as some energy majors flush with cash have rethought their approach to hydrocarbons and their importance for investor returns. This has had analysts rushing to revise up their output forecasts, no longer being fixated on the Permian but looking at other production patches such as the Bakken, the Eagle Ford and the Gulf of Mexico.
Stability around the $80/bl mark has never looked so fragile
There is certainly merit in the upbeat outlook, but it comes with several caveats. Record US output is a headline that is set to be written again and again as US production growth hits fresh highs, and this will probably prompt the happy clappers to talk up US energy independence, market power and market share, especially when compared with OPEC. But the pace of growth remains key, and it will be important to watch for the old drivers of conservative increases—capital discipline and shareholder returns—especially given wage growth and input costs in an inflationary environment.
There is even a case to be made that there may be a pause in the record rises in US supply, especially if oil prices creep lower rather than higher in the months ahead. Given this is an election year in the US, the role of oil will be a huge political football for those looking at the market from a consumption angle—in terms of the price at the pump—from a production viewpoint—as a home-grown business—or in terms of the wider environmental and security perspectives.
For some, all it takes is for one OPEC member with declining oil output to leave the group for the ‘OPEC is dead’ trope to be resurrected. Angola’s departure at the end of 2023 was neither that surprising nor without precedence. Ecuador, Indonesia and Qatar all left when national objectives were at odds with wider geopolitical strategies. OPEC+’s core strength to manage the market lies first and foremost with the inner circle of Saudi Arabia and the Gulf producers. But the UAE’s less-than-clear dynamic in the group since Russia came on board with the start of OPEC+ around eight years ago could come under renewed scrutiny this year.
The UAE has built out greater spare capacity, in a similar vein to Saudi Arabia, putting it in close proximity to the OPEC kingpin but potentially with less conviction around the merits of market management—especially at the expense of continued lost revenue. But one should not disregard the Gulf alliance, even with the crucial Saudi-Russia relations that are key to the wider group. Just look back to the early days of OPEC+, when Iraq was having huge compliance issues with quotas but both sides saw the bigger picture: the value of a founding member staying in the group and tolerating the challenges facing it. Indeed, producers hit by sanctions or internal struggles—such as Venezuela, Libya and Iran—have all stayed, given the importance of unity.
OPEC+’s commitment to a high-price strategy could be tested, especially through the first half of 2024, but anyone claiming the Saudi strategy is not working is merely denying the counterfactual of what would be happening without OPEC’s intervention. Those suggesting Riyadh is losing money by cutting output to keep prices higher are not paying close enough attention: the link between Saudi GDP and oil prices is closely correlated. And be careful of anyone calling OPEC a cartel, in particular when also discussing its lost market share due to Angola’s departure or the rise in non-OPEC crude. OPEC will surely be tested, but it is an exam it has taken and passed many times in the past.
Global economic prospects
The outlook for oil demand revolves around the US and China. And there is enough evidence for both optimists and pessimists to seize on as a barometer for the economic outlook in 2024. Those pinning their hopes on a recovery will look to the way US inflation is close to being beaten, the robustness of the US jobs market and the fact that the worst of China’s property problems seem to be in the rearview mirror.
OPEC will surely be tested, but it is an exam it has taken and passed many times
Those with a cynical disposition will note that US interest rates could stay stubbornly high, especially if inflation struggles to get below the Federal Reserve’s target, and thus keep demand in check. Meanwhile, China is still seeing falling property prices, which are not conducive to consumption, especially given that the lion’s share of Chinese wealth is invested in the residential sector.
What is probably key is how much reality matches up with expectation and where the biggest risks lie: they are well and truly to the downside, but that could change quickly if the US sees off inflation and the rising tide lifts all ships. It will also be interesting to see how the market processes the interest rate-inflation dynamic in 2024 as a bullish or bearish phenomenon.
While higher interest rates suggest a weaker growth outlook, for much of 2023 tighter monetary policy was seen as positive because it was about getting inflation under control and thus the first step to recovery. The longer the recovery takes, the greater the risk that China’s property concerns or US financial health—remember the banking wobbles of 2023—could once again start to creak and keep demand in check. At the same time, should there be a quick recovery, you will see headlines of ‘oil demand at record highs’ being written on repeat for the market bulls, environmental wonks and clickbait suckers alike.
Russia’s invasion of Ukraine provided some key lessons. First, that when oil supply is threatened the risk premium is huge—oil prices jumped to close to $130/bl on fears of disruption to some 11m b/d of Russian supply. Second, that given the risks, nobody really wants to lose that supply and will do anything to ensure the disruption is minimised—from absurd sanctions and price caps that are actually designed to allow oil to get to market to new supply routes and diversified supply options.
While 2024 sees the supply risks largely through the lens of shipping chokepoints, the message remains similar. This can be seen with the Red Sea attacks, which have led to a combination of military action, continued seaborne trade through vulnerable waterways and costly rerouting and renewed pipeline infrastructure discussions. But with more than half of the world’s oil supply transported via chokepoints—and with some of these arteries so narrow there are restrictions on the size of vessels—and limited pipeline alternatives, the maritime map is important to review.
The conflict between the Iran-backed Houthi militia in Yemen and the opposing Saudi–UAE-led coalition continues to provide a source of risk and threatens the flow of Middle East crude through key waterways. Around 7m b/d of crude oil, condensate and refined petroleum products transits the Bab el-Mandeb strait, at southern tip of the Red Sea, to markets in Europe, the US and Asia.
The tensions around the Bab el-Mandeb—which has seen a number of tanker attacks in recent years—have brought into focus the Suez Canal, which links the Red Sea with the Mediterranean and accounts for 10% of seaborne oil trade. The blockage of the waterway by the Ever Given container vessel in 2021 served as a reminder of the route’s importance, with around 5m b/d of crude and refined products estimated to pass through the canal. Then there is the 21-mile-wide Strait of Hormuz, a major artery that sees more than 20m b/d of all seaborne exports pass through it. Iran has threatened to close the chokepoint in recent years, prompting the US to deploy additional warships and military aircraft. Saudi Arabia, the UAE, Oman and Iran have alternative shipping lanes, but risks to the strait would be the most significant source of concern for the oil market.
Big oil is getting bigger. On top of the ExxonMobil and Chevron deals, which redefined the oil and shale industry, Occidental Petroleum has snapped up CrownRock, a lucrative US shale producer, for $12b including debt. This puts Oxy as the second-largest player in the Permian. Meanwhile, ConocoPhillips looks to be hunting for targets in the shale patch. By the end of 2024, four energy companies will control at least half of all Permian production. The oil industry is now looking to CrownRock’s peers for the next tight oil deal, with Endeavor Energy Resources and Mewbourne Oil as prime candidates, according to analysts.
The conflict between the Iran-backed Houthi militia in Yemen and the opposing Saudi–UAE-led coalition continues to provide a source of risk
Consolidation helps producers but hampers service companies, squeezing their margins as existing contracts are looked to be renegotiated. Pipeline operators face their own consolidation wave, with fewer new oil and gas pipes being approved and built. Expansions to existing lines out of the Permian Basin will provide some relief, but there is the risk of bottlenecks to pipeline capacity during the second half of the decade, some analysts have said.
The emergence of fewer, bigger oil producers focused on extending the longevity of their hydrocarbon business in the US raises the question as to whether this model will be replicated in other parts of the developed world—such as Europe or Australia. One must also consider how this changes the relationship between IOCs and governments as well as with NOCs, especially in terms of exploration and production against a backdrop of changing policies towards emissions and energy producers.
Source :Petroleum Economist