A Crude Oil Price Surprise For 2020?

Saudi Arabia rode to the rescue of crude oil prices yet again by pushing through 500,000-bbl-day of additional output cuts for the first quarter of next year. This was reportedly after putting the price war gun to the heads of fellow OPEC+ members, especially laggards to the previous production pact such as Iraq, Nigeria and Russia.

Assuming these cuts are extended through the final three quarters of next year at a so-called extraordinary meeting to be held in early March, the global oil market should be in balance next year based on projections by the leading oil forecasting organizations — International Energy Agency (IEA), U.S. Energy Information Administration (EIA) and OPEC.

This should lead to modest upward pressure on crude oil prices in the first half of next year, before a rebounding U.S. rig count, continuing productivity gains and greater growth in the country’s light-tight oil (LTO) production again weighs on the market.

Despite this relatively subdued outlook for crude prices, Geopolitics Central (GPC) now believes the greatest risk for prices is on the upside and substantial, with the Abqaiq attack in mid-September a possible harbinger of things to come for Persian Gulf oil supply.

OPEC+ rollover

On December 5, OPEC and its oil-exporting allies effectively agreed to output cuts of 2.2 million bbls/d for the first quarter of 2020. The 14 OPEC members and 10 non-OPEC countries that have come to be known as OPEC+ agreed to curtail production by 1.7 million bbls/d, with OPEC shouldering around two-thirds of these cuts, while Saudi Arabia agreed to continue its voluntary additional cut of 400,000 bbls/d.

At a technical meeting two days before, as reported by The Wall Street Journal (WSJ), a Saudi delegate said his government is growing tired of indirectly supporting countries flouting the OPEC+ pact, and would end its voluntary additional cut if the non-compliance continued. The WSJ also reported that Saudi Arabia expected watertight guarantees of 100 per cent compliance when advocating for the 500,000 bbls/d of additional cuts for the beginning of next year.

Although this appears to suggest the kingdom will not push to have these cuts rolled over to the final three quarters of next year if compliance remains relatively poor by some countries, GPC views this as highly doubtful for a simple reason. Saudi Crown Prince Mohammed bin Salman needs relatively high crude prices on an ongoing basis to support the share price of Aramco and the sale of additional tranches of shares in the state-owned oil company to finance his ambitious Vision 2030 economic modernization and diversification program and Cold War with Iran.

U.S. LTO

The trajectory of U.S. LTO production has been the dominant factor in the world oil market since early this decade, and in the view of GPC should continue to be so for at least a few more years. It is true year-on-year growth has declined by almost a half from a massive 1.90 million bbls/d in August 2018 to 1.01 million bbls/d in October (the latest month in which EIA data is available), but this is simply due to a declining rig count courtesy of a roughly 10 per cent decline in crude prices this year compared to last.

New well productivity continues to improve for the seven U.S. LTO basins as a whole, with continued rapid improvements in the all-important Permian Basin as well as Anadarko, and modest improvement in the other three major oil producing basins — Bakken, Eagle Ford and Niobrara.

Much has been made of so-called child wells being up to 20 per cent less productive than parent wells in a given drilling region, due to wellbore production interference and possibly low-pressure sinks, but this is likely more of a medium to longer term issue for the U.S. LTO industry with prime targets remaining available for fresh drilling. At the same time, the solution for this problem has already been identified, the drilling of parent and child wells at the same time. This is a costly endeavor, but should be supported by increased consolidation in the industry, especially by deep-pocketed supermajors such as Chevron and ExxonMobil.

As previously mentioned, a modest rebound in crude oil prices in the first half of next year should help revive the U.S. rig count and growth in U.S. LTO production, which will weigh on crude prices in the second half.

Iran card

The leadership of the Islamic Republic of Iran has repeatedly warned since the middle of 2018 that if it cannot export its oil and condensate due to U.S. imposed economic sanctions, it would make sure supply from other major Persian Gulf exporters suffered a similar fate. (The memory remains remarkably fresh in Iran of the 1951-53 oil embargo that toppled the democratically-elected government of Prime Minister Mohammed Mossadegh — and the CIA installing the despot Mohammad Reza Pahlavi, the so-called Shah of Iran, in his place).

This was generally viewed as a threat to close the all-important Strait of Hormuz to maritime traffic, until the relatively successful armed drone and cruise missile attack on Saudi Arabia’s Abqaiq oil processing plant and the Khurais oil field on September 14. As argued in Drone Revolution Threatens Eastern Canadian Oil Imports, drone and cruise missile technologies and tactics have recently gotten ahead of available air defense systems, making already highly combustible oil and gas facilities easy targets.

At the present time, Iranian crude and condensate exports have been slashed to a mere 250,000 bbls/d, compared to 2.7 million bbls/d prior to the U.S. reimposing sanctions, the country’s economy is in free fall, and recent massive anti-regime protests were only subdued through brutal repression. As the Iranian leadership becomes increasingly desperate, we should expect additional armed drone and cruise missile attacks on oil facilities in Saudi Arabia and its regional allies such as United Arab Emirates and Kuwait, if not an attempt to close the Strait of Hormuz to maritime traffic (see Three Scenarios For A Strait of Hormuz Closure).

To conclude, GPC is forecasting spot Brent crude to average US$64/bbl this year and US$65 in 2020, roughly the same as our September predictions, as we had assumed further cuts by OPEC+ for next year to balance the market. Spot West Texas Intermediate (WTI) at Cushing is assumed US$7.25/bbl less than Brent in 2019, and US$5 less next year, as U.S export and other infrastructure constraints rapidly decline. But, it is important to add, the risk to crude prices is on the upside and substantial.