In the absence of a major financial meltdown, oil will end 2016 north of $60 a barrel,” this column stated at the turn of the year. It was a forecasting flourish possibly fuelled by one Christmas brandy too many. With just four months of 2016 to go, though, I’m sticking to my Yuletide view.
Attempting to predict the oil price is crazy. Yet no decent economist can afford not to. The world economy still revolves around oil – used in everything from transport and electricity generation to the production of plastics, synthetics and so much else. And for all the breathless talk about renewables, and the grim inevitability of growing nuclear dependence, we remain addicted to oil.
As recently as 2005, world crude consumption was just 84.7 million barrels a day. That’s since gone up to 95.1 million daily, a 12pc increase in just 10 years. And that rise came during a decade when global GDP growth was rather sluggish.
Had the world economy not endured the 2008 financial crisis, and subsequent stop-start recovery, oil consumption would have grown even more. But still, for all the expansion of wind and solar, and endless hype about a “post-petroleum world”, oil consumption continues to rise relentlessly – and that won’t change any time soon.
The oil price has surged this month, up from around $41 a barrel in early August to almost $52 last week, before falling back slightly. This 20pc-plus increase puts crude technically into “bull market” territory. This is striking, not least because from mid-June to the end of July, oil was in “a bear market”, having dropped over 20pc. Despite this summer volatility, though, the direction of travel is clear. Oil has been climbing steadily, if not always in a straight line, from its February low of $28 a barrel.
This August rise in oil prices stems from market fundamentals on the one hand, and geopolitical speculation on the other. Earlier this month, the highly respected International Energy Agency (IEA) published a report suggesting global crude supply will fall short of demand during the third quarter by nearly a million barrels a day.
This projected deficit comes despite the fact that the Opec exporters’ cartel continues to pump like billy-o. Having traditionally restricted supply to keep prices high, Opec has over the last two years been doing the reverse, of course – flooding global markets with oil, lowering prices to squeeze high-cost US shale producers out of existence.
Amidst record production by Saudi Arabia, Kuwait and UAE, total Opec output hit an eight-year high in July, up no less than 840,000 barrels a day on the same month in 2015.
This Opec supply surge was more than offset, though, by the dramatic ongoing slump in output from producers outside Opec. Declines in the US, China, Canada and Mexico combined to push non-Opec production down by more than 1.1 million barrels a day compared to July 2015.
Total crude pumped last month, then, within Opec and beyond, was 215,000 barrels down year-on-year. This eye-catching outcome helped to drive the International Energy Agency’s forecast of a significant crude shortfall between July and September – which, in turn, helped to push prices up.
On top of this technical evidence of a tightening oil market, there are signs Opec may soon come to an output-limiting agreement, putting more upward pressure on prices.
Back in mid-2014, de facto cartel leader Saudi Arabia announced a production hike in the face of falling prices – an aggressive bid to protect Opec’s market share. Oil subsequently plunged 70pc over 18 months, surely more than the Saudis expected. This dramatic fall, from over $100 to less than $30 a barrel, harmed not just upstart shale and tar-sands producers in the US and Canada as intended, but also Opec members – not least the mighty Desert Kingdom itself.
The International Monetary Fund estimates that low prices cost the big Arab oil exporters almost $350bn (£265bn) last year. Dependent on crude for more than 90pc of its revenue, the Saudi government is now nursing a budget deficit approaching a colossal 15pc of GDP.
Typically the world’s largest crude producer, the Saudis clearly now want higher prices. The trouble will be getting all other Opec members to agree – not least Iran. Then there are the Russians, outside Opec but obviously a major player on international oil markets. Russia typically pumps more than 10 million barrels a day, after all, often outpacing the Saudis.
An informal Opec summit is scheduled a month from now in Algiers. Throughout August, leading Opec members – not least new Saudi oil minister, Khalid al-Falih – have said “price stability will be discussed” in the Algerian capital.
There’s much scepticism a deal can be struck, of course. A similar Opec “showdown” in Doha back in April failed to produce a production-cap agreement. And Opec quota-cheating – with members often pumping beyond agreed limits to garner extra revenue – means the cartel is riddled with distrust.
The key fissure within Opec is that between predominantly Sunni Saudi and overwhelmingly Shia Iran. This ancient Tehran-Riyadh schism has undermined the cartel’s coherence in the past and these days there’s an extra complication. Iran’s oil-export sanctions were lifted by the United Nations only in January.
So the Islamic Republic, despite its Opec membership, has been reluctant to agree to any Saudi-led initiative to limit supply, just at a time when Tehran has been trying to restore Iran’s place as a leading global supplier.
Significantly, Iranian oil minister Bijan Zanganeh last week confirmed he will attend the Algiers meeting in September. Iran’s absence in Doha was, according to the Saudis, the main reason that summit failed. Seven months after export sanctions were lifted, Iran’s production has soared from under three million to over 3.8 million barrels a day, but remains short of its four million pre-sanction level. Having said that, Iranian output has plateaued over the last two months – which has fuelled speculation Tehran might agree to co-ordinated Opec action to limit supply.
If there is a deal in Algiers, and it binds – with Opec holding together, and the Russians staying on board – then my end-of year oil prediction, in the absence of a Lehman-style global meltdown, will almost certainly come true.
Such geopolitical stargazing has helped push up oil prices this month. During the first week of August, short crude oil positions on the NYMEX, one of the world’s leading commodity exchanges, were at a 10-year high. A large number of traders, in other words, thought oil was set to fall back towards $30. That view has now been thoroughly trounced, with the resulting “short squeeze” helping to drive this latest 20pc oil price rise.
Aside from speculation and diplomatic wrangling, though, there’s growing evidence of an emerging supply-demand deficit.
Buried in the IEA’s latest report is the significant observation that it expects a further 900,000-barrel reduction in non-Opec output by the end of this year.
This Saudi-driven price war has seen global investment in oil exploration and field development cut by $300bn, some 41pc, since 2014. The “active rig count” – the number of wells being pumped worldwide, is down 37pc.
Before these trends are slowed, let alone reversed, oil will need to spend at least six months, and probably a year, firmly above $60 a barrel, if investors are to be convinced profits can be made, so persuading them to put serious money back into future crude production.
Unless global markets crash, I say that year of $60-plus oil will be 2017.