Forecasting the oil price, as I’ve often said, is a mug’s game. But the cost of the black stuff is so important – central not just to transport and electricity generation, but also agriculture, the production of plastics and synthetics and so much else – that any self-respecting economist simply must take a view.
“In the absence of a major financial meltdown, oil will end 2016 north of $60 a barrel,” this column asserted at the turn of the year, possibly after one Christmas brandy too many. Despite yuletide excess, I’m sticking to that view.
Last week oil jumped above $44 – it’s highest level so far in 2016. Having sunk to a 12-year low in mid-February, crude prices have since risen 40pc. The Opec oil exporters’ cartel is now trying to forge an output-limiting agreement, ending a two-year supply glut and pushing prices further up. So, all eyes are on today’s Opec summit in Doha.
Back in mid-2014, de facto Opec leader Saudi Arabia announced a production hike into the face of falling prices. The idea was to drive prices down more and knock high-cost North American shale producers decisively out of the market, so protecting Opec’s market share.
As Saudi, Kuwait, Venezuela and other large Opec members flooded world markets, crude fell and then began to nose dive, plunging 70pc over 18 months. While many shale outfits in the US and Canada were clearly hit, the extent of the drop meant low-cost Opec members suffered badly too. Nursing depleted financial reserves, a 15pc-of-GDP budget deficit and multiple sovereign debt downgrades, even Saudi itself, the once impregnable Desert Kingdom, is now under serious fiscal pressure.
So Saudi wants prices to rise – or, at least, not fall sharply back towards $30, or even below – as that would push the finances of leading Opec members over the edge. Low prices cost the big Arab oil exporters almost $350bn last year, according to the International Monetary Fund. Such countries rely on crude for around 80pc of all government revenue, rising above 90pc in the case of Saudi.
Doha could well produce a deal between Saudi and non-Opec member Russia – the world’s top two crude producers. Some observers are skeptical, suggesting there’s so much Opec quota-cheating – with members pumping beyond agreed limits to garner extra revenue – that the cartel, riddled with distrust, has now lost all coherence.
I’d say some kind of deal will happen, though, with Riyadh and Moscow putting on a show of strength – not least as both governments want a higher oil price so badly. If we do see a deal, and it binds, my end-of year oil prediction – in the absence of a Lehman-style global meltdown – will almost certainly come true.
That’s because, with oil having been low for a while now, production has become uneconomic for many high-cost producers. Total non-Opec output has dropped 700,000 barrels a day to 57m so far this year – the biggest non- Opec fall in almost quarter of a century. While US shale producers have shown resilience, carving out efficiencies, America’s daily crude output went below 9m barrels last week for the first time in 18 months.
As a result, the global surplus of crude production over consumption, estimated at 1.5m barrels daily so far this year, is set to collapse to just 200,000 during the second half of 2016, according to the International Energy Agency, the Western world’s energy think-tank. On the demand side, meanwhile, despite slowing global growth, the IEA remains confident world oil consumption will keep rising this year, by 1.2m barrels a day or 1.3pc, with a booming India close to surpassing a slowing China as “the main engine of global demand growth”. With the fundamentals also pointing to higher oil, then, a deal in Doha could spark rather a rapid rise in crude.
As a net oil importer, the UK appears to lose if oil prices rise. But there are important caveats to that view. The North Sea oil industry, once a huge money-spinner for the Treasury, has lately become a burden. The latest forecasts from the Office of Budget Responsibility, announced in the March Budget, show that while oil companies generated £11bn of tax revenues as recently as 2012, they’ll represent a £1.1bn drain on the Exchequer in 2016-17, once payments related to platform decommissioning costs are included, a loss repeated each year until 2021. So dearer crude, by increasing North Sea volumes and operating margins, will benefit the UK’s public finances.
A higher oil price also brings benefits in that, as things stand, cheap crude threatens to spark a nasty financial collapse. Since Opec put the squeeze on domestic US energy producers, resulting poor cash flows have stymied their ability to pay creditors – including many big Wall Street banks – who readily put up money to drive “America’s shale miracle”. With distressed debt now at levels not seen since the peak of the 2008 crisis, American energy bonds are being dubbed “the new sub-prime” – and could pose broader systemic dangers. Higher oil prices would help us all dodge that bullet.
Having said that, if any Doha deal binds too tightly, and oil goes up sharply, a even greater systemic threat could loom. Over recent weeks, far from seeking to cope with the US Federal Reserve’s earlier indications of rising interest rates, financial markets have become used to the idea that the next rate move – in the US, Eurozone and possibly even in the UK – could actually be down, even if that means more nations entering negative-interest-rate territory.
While UK inflation hit a 15-month high in March, it remains at just 0.5pc, well below the Bank of England’s 2pc target. An oil price spike, though, could suddenly send headline inflation figures skyward – in the UK, US and elsewhere. That would, at best, seriously complicate the already tricky task big Western central banks face to “normalize” monetary policy.
The whispered assurances that rates will remain flat and could even fall further – instrumental in keeping skittish stock and bond prices steady – could look less convincing if oil rises too far too fast, and inflation comes back from the dead. Yes, financial markets have lately quite liked higher oil prices, as they suggest the world is returning to normal. But if an oil-induced inflation spike threatens to spark higher interest rates, such sentiments will rapidly switch.
In the here and now, as far as Doha is concerned, the geopolitics are key. Saudi and Russia are far from natural allies. On opposite sides of the Cold war, these two energy behemoths have since competed bitterly to supply fast-growing China. Most recently, of course, they’ve been on opposite sides of the Syrian civil war.
Even if Moscow and Riyadh can agree, though, in the end, the credibility of any production-limiting agreement, and its medium-term impact on oil prices, will depend on that recently awakened energy giant, Iran.
Since January, when oil-export sanctions were lifted following a deal on its nuclear program, Iran has boosted its production by 400,000 barrels a day, to 3.3m. While significant, this rise has been somewhat slower than expected – which has contributed to recently stronger oil price.
So far in April, though, Iran has been exporting as fast as possible, increasing crude shipments by over 600,000 barrels a day. Years of sanctions, and ancient enmity towards Saudi, mean Tehran – despite Iran’s Opec membership – could seriously undermine any production-limiting deal. Predicting the oil price has never been easy. It’s especially difficult now.
Follow Liam on Twitter @liamhalligan