The Vienna Alliance of OPEC and non-OPEC oil producers decided in December 2018 to reduce oil supply from October levels by a collective 1.2mmbpd starting in January 2019, effectively reversing a supply expansion of 1mmbpd that was agreed at its last meeting in June. OPEC will account for 800,000 bpd of that cut, and 10 non-OPEC members of the alliance will account for the remaining 400,000 bpd. Saudi Arabia and Russia, the two largest producers in the alliance that accounted for the lion’s share of increased output in recent months, will nominally be reducing supply the most. Had the alliance failed to agree to cut supply, the markets were poised to fall further.
Russia, the most critical non-OPEC partner, has agreed to cut about 230,000 barrels a day but says this will take time to achieve due to seasonal factors related to harsh winter conditions at oil fields in Western Siberia. Russia was slow to hit its 300,000 barrels per day commitment in 2017, when it first partnered with OPEC in supply cuts, requiring several months to reach 100% compliance. With the new deal only running six months, Russia looks less likely to fulfill its commitment this time — particularly since Russian oil companies aren’t thrilled about OPEC action stunting their growth plans.
Saudi Arabia will once again shoulder the biggest cuts among OPEC members and draw the most attention in markets. However, the oil-rich kingdom’s actions could confound markets. Saudi Arabia plans to cut its production to 10.7 million barrels a day this month, down from a record 11.1 million barrels a day in November and cut further to 10.2 million barrels a day in January to emphasise its commitment to the new OPEC deal.
Saudi Arabia, Russia, and the alliance seem resolved to tame oil markets despite their capriciousness. Just this year, the alliance has had to adjust to several new factors: a rising tide of oil supply from the United States, which just last week became a net oil exporter, something that was unthinkable 10 years ago; heightened trade tensions that threaten to reduce the flow of goods and services, and thus economic growth; the prospect of slower global economic activity for cyclical and other reasons.
Production cuts by the “Vienna Alliance” should keep the market balanced, allowing a modest recovery in prices. These cuts, in addition to an expected steep fall in Iranian supply, should keep the market balanced on average in 2019, although Q1 2019 could be challenging given the seasonal decline in oil demand.
Oil markets are typically in a state of unstable equilibrium, with either a little too much or a little too little oil supply—small imbalances that tend to disproportionately buffet prices. Managing such fluctuations demands constant adjustment. US waivers in connection with Iran sanctions will run out in May and will either be renewed at some level or ended, creating yet more uncertainty about demand for oil from other producers. Global supply prospects are such that they may exceed demand growth, the more so if the latter is weaker than currently expected for any reason, caused perhaps by the impact of the US administration’s trade wars or a slowdown in overall global economic growth. At the same time, US production is due for another big increase in 2019, once transportation and other infrastructure bottlenecks are cleared in the Permian Basin. To the extent that US production rises, it will reduce the need for OPEC and alliance oil.
The United States poses multidimensional risks for the global oil market. Most of the world’s supply growth in 2019 is expected to come from the United States. This poses a risk of oversupply—or a shortfall if the United States fails to deliver. Other risks are political, such as the degree to which US President Donald Trump exerts pressure on Saudi Arabia to increase output.
Crude oil output from the big three—Saudi Arabia, Russia, and the United States—has grown far in excess of the decline in Iranian crude output so far, forcing the “Vienna Alliance” back into a market management stance. However, we expect the production cuts agreed to on 7 December are sufficient to return the market to balance in 2019, allowing a modest recovery in prices.
The “Rule of Three”: US, Saudi Arabia and Russia carry global supply. Power within the oil market is quickly gathering around the three super-producers: Saudi Arabia, Russia and the US. These three countries, above all others, are now calling the shots in the global oil market, and will be critical in supplying the market over the next few years, offsetting declines in non-core OPEC output and flat growth in non-OPEC countries outside North America. The United States is currently setting the global oil agenda, forcing the other two oil superpowers, as well as OPEC and the Vienna Alliance, to react to US initiatives.
US tight oil economics remain strong, driving production growth. US supply growth continues to be propelled by the Permian Basin, which boasts the lion’s share of premium tight oil well locations. Most new US production growth in our outlook comes from wells that break even below $50 per barrel (WTI). However, if drilling and completion activity slows or halts, overall US output could drop steeply for a time, because of the accelerating decline of the tight oil production base.
The Brent-WTI spread will remain relatively wide in 2019 as the US crude export requirement rises and Cushing congestion worsens. Crude inflows into Cushing (delivery point for the NYMEX WTI contract) are expected to outpace crude outflows over the coming year, resulting from higher utilisation of pipelines into the hub, including expansions. Arbitrage economics on the US Gulf Coast will also stay positive to support a rising trend of crude exports, which will occur as shale output climbs higher. By 2020, we expect WTI to begin strengthening relative to Brent, as the Permian and Cushing are debottlenecked with new pipeline capacity, and as the IMO bunker specification puts a premium on light sweet crudes like WTI.
A $60-70 per barrel oil price level appears adequate to incentivise sufficient long-term supply. The cost to develop both tight oil resources and conventional upstream oil projects has declined significantly since the oil price collapse of 2015-16. Full-cycle breakeven levels for deepwater projects are now comparable to typical US tight oil wells. We estimate that most of the gross supply needed in our long-term outlook can be supplied at $70 or below. As always in the oil market, volatility will remain. Excursions well above or below this average long-term price level will occur periodically over the outlook period as supply and demand adjust.
