Doom and gloom – or another oil boom?
The former very much characterises the economic sentiment in the Arabian Gulf during the first quarter of 2016, writes Ben Flanagan.
In January, the oil price sank below $28 for the first time since 2003, amid a wider climate of layoffs and cost-cutting.
Things certainly look bleak for the oil industry – but some are more optimistic than others about what the year will bring. Here are Benchmark’s top trends to watch in 2016.
Oil prices to remain relatively low …
Brent crude oil prices dipped below $28 on January 18, in what some said was a reaction to the ending of sanctions on Iran – and many analysts believe that prices will remain low for some time, at least compared to the $100-plus levels seen a few years ago. The U.S. Energy Information Administration expects Brent to average $40 per barrel in 2016 and $50 in 2017. Trevor McFarlane, chief analyst at the Dubai-based Emerging Markets Intelligence and Research, said he expects oil prices to recover to above $50 later this year. “The market consensus is that you’ll start to see the oil price rebound in the second half,” he said. “But still… not until the end of the decade are we going to see oil prices around $100 a barrel again.”
… Yet how low, we don’t know
Some however have doomsday-like predictions for the oil price. Morgan Stanley analysts have said “oil in the $20s is possible” if China devalues its currency further, while economists at the Royal Bank of Scotland says that oil could fall to $16. But Standard Chartered has perhaps the gloomiest prediction: That oil prices could hit just $10 a barrel. Yet the truth is, no one really knows where the price will go. “There’s a lot of uncertainty around where the oil price is going to be,” said McFarlane. “Sometimes we need to say that we just don’t know.”
Cost-cutting, but not closures
McFarlane said he expects cost-cutting in the Gulf energy industry to continue this year. “You’re seeing layoffs. You’re seeing price pressure being applied from the national oil companies to the suppliers. There will be a continuation of this trend,” he said. “2016 is going to be a year for a lot in the oil and gas industry to get through, rather than to thrive.” But cost-cutting moves won’t go as far as actual closures, said Robin Mills, head of consulting at Manaar Energy, and author of ‘The Myth of the Oil Crisis’. “I expect cost cuts – around 20 to 25 percent – in the Gulf’s oil industry, particularly affecting contractors,” Mills said. “But the Gulf oil industry is low-cost and will be the most robust in the world. Major strategic projects will still go ahead, and fields will not be shut down.”
The cure for low oil prices: Low oil prices
The end of the era of low oil prices can be summarised by one rather counterintuitive maxim: “The cure for low prices is low prices,” said Mills. “Certainly oil prices can recover… but I expect an extended period of weak prices, even if above today’s levels,” he added. McFarlane agreed that the sooner the oil price hits rock bottom, the sooner it will start to recover. “We tend to be bullish on the way up and bearish on the way down – that’s the way markets work,” he said.
A global oil glut, despite low prices…
Despite the massive drop in oil prices over the last 18 months, the world’s producers are still pumping – sending prices even lower. The International Energy Agency warned in its first monthly report of the year that “the oil market could drown in oversupply” unless something changes. The markets could be left with a surplus of 1.5 million barrels a day in the first half of this year, it added.
… But US output to decline
The Organization of the Petroleum Exporting Countries said in January that it expects production outside the Opec area to drop by 660,000 barrels a day. The United States is expected to see the biggest decline in production, with the country’s output forecast to fall by 380,000 barrels a day. McFarlane said that while many had underestimated the shale revolution, production from the US has indeed slowed. “The expectation is that that will continue throughout the year,” he said
Iran production in focus
Iran currently pumps about 2.9 million barrels per day, but there is some debate over the extent to which it could boost oil production as sanctions are lifted. Iranian officials have said the country is preparing to increase production by 500,000 barrels per day, and could push this to one million. But some oil analysts have cast doubt over Iran’s ability to do this, given that many of its oil fields are aging and in need of investment. The IEA says Iran could add around 300,000 barrels a day of crude by the end of the first quarter. Whatever the output from Iran, Mills said he expects an impact on the market. “Oil prices have fallen unexpectedly low, and extra Iranian oil will keep them low this year. But I expect [an oil price of] around $40-50 per barrel by the end of the year,” Mills told Benchmark.
All eyes on China
Despite the reaction to the lifting of sanctions on Iran, it is what happens in China that has the far bigger impact on the market, some commentators say. And economic jitters in the world’s most populous country have been sending shockwaves through the industry, says McFarlane. “China remains a kind of panic button for the global economy. We’ve seen a lot of stock market volatility. And when this volatility in China happens… the sentiment very quickly spills into the commodity market,” he said.
Less appetite for exploration
Some Gulf states, faced with huge budget deficits, are likely to divert funds earmarked for oil exploration elsewhere, McFarlane said. “They need this capital to flow to other areas,” he said. Daniel Ang, an investment analyst at Phillip Futures in Singapore, said that he predicts capital expenditure to be lower, but said that some exploration may continue. “I would think that the main theme [this year] would be lower capital expenditure on development of oil rigs. It is possible that exploration could still be ongoing, however, the checks on profitability of the oil wells would very stringent,” Mr Ang told Benchmark.
And finally – some good news
Despite the short-term doom and gloom, this period of low oil prices will ultimately be a good thing for the Gulf economies, said McFarlane. The cut in petrodollar income has expedited positive economic reforms such as ending fuel subsidies in markets like the UAE, for example. “In the grand scale of things this low oil price could be a really good thing, because it forces the governments to reform,” said McFarlane. “Again, the UAE government has led the way, I feel, in terms of setting a positive example in terms of cutting subsidies. They need further economic reforms.”