A tight market, underinvestment characterize global oil sector
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Energy ministers and industry leaders have gathered in Abu Dhabi to attend the four-day ADIPEC conference amid a tight oil supply outlook. Prices of Brent and West Texas Intermediate are up more than 25 percent and 30 percent in the third quarter respectively.
We are seeing very robust demand growth as industrial activity picks up, especially in the US, and as travelers again take to the skies with air travel nearing pre-pandemic levels. The Organization of the Petroleum Exporting Countries predicts demand growth of 2.4 million barrels per day for 2023 and 2.2 million bpd for 2023. The International Energy Agency’s number is at 2.2 million close to OPEC for 2023.
The demand picture stands against supply cuts from OPEC and its allies including Russia, also called OPEC+, especially the hotly debated 1.3 million voluntary extra cuts which Saudi Arabia and Russia extended to the end of the year. Many analysts expect them to remain in place when ministers take a fresh look at the data during the Joint Ministerial Monitoring Committee on Oct. 4.
While OPEC+ has received a lot of flak for holding on and extending the voluntary cuts, they do make sense when drilling down on some of the data.
For one there are the higher longer interest rates in member countries of the Organisation for Economic Co-operation and Development, which will have an impact on economic activity.
Then there are the numbers out of East Asia, which is a hugely important market for both Saudi Arabia and Russia.
China’s demand growth has been more sluggish than expected, as the country faces several economic woes — none the least a real estate crisis. The September manufacturing Purchasing Managers’ Index, which is a measure closely watched by economists to understand developments in the manufacturing sector, turned marginally positive at 50.2 for the first time since March.
Still, this growth is anemic at best, especially going into the most important quarter for manufacturing ahead of the Christmas season. The rest of East Asia looked less positive with contracting figures for Japan, Taiwan, and Indonesia all below 50, indicating a contracting sector. Indeed, the World Bank revised its growth forecasts downward to 5 percent for 2023 and 4.5 percent for 2024 down 0.1 percent and 0.3 percent respectively.
Even if China grows, the country has added to its inventories to the tune of around 800,000 barrels a month during the first half of the year from which it can now draw.
Europe’s economy is also cause for concern with Germany, which was traditionally the continent’s growth engine — expected to contract marginally this year.
Taking everything into account we are left with a market that is in deficit, which is largely induced by supply constraints. There are not just the cuts from OPEC +, there is also the US, which is still the world’s largest oil producer. However, the US shale industry does not respond to markets as swiftly as it did in the 2010s. This is a reflection of several factors as it has become technically more challenging to produce the incremental barrel added by substantial inflation in the oil field services sector. Deleveraging and capital discipline also add to constraining the flexibility in the shale oil sector.
All of this is reflected by the ultimate sign of a tight market: backwardation. It has risen to $8.5 between the one- and six-month contract for Brent in September, according to UBS.
All in all, markets are tight, and no one expects prices to fall while OPEC+ production restrictions remain in place. However, looking at the macro-economic picture, especially the constrained growth in East Asia, which is a very important market for OPEC+ barrels, one can understand the cautious attitude of the oil producers’ group.
The higher prices may hopefully induce more investment in the sector at large which is hugely underinvested due to pandemic contraction and a challenging environment. The OPEC secretary-general expects that in order to meet long-term demand the oil and gas sector requires around $12.1 trillion of investment until 2045.
• Cornelia Meyer is a Ph.D. level macroeconomist, energy expert and CEO of Meyer Resources, a business consultancy.
Twitter: @MeyerResources
