Despite the recent agreement among major producers including Saudi Arabia and Russia to cut crude oil production and support prices, the momentum seems to be slowly but surely turning against any sharp price escalation in the energy market. If anything, the market might be vulnerable to a decline.

A look at the market drivers tells the story. The trend of rising production and expanding inventory continues. Global inventories are rising relentlessly. On a year-on-year basis, inventories are up 7 per cent.

Buoyed by the price rise of recent months, US shale oil producers are back with a bang. The rig count is rising steadily, suggesting optimism among shale producers. According to reports, the rig count currently stands at 631, the most since September 2015. This implies a further increase in US production.

Since last July, US shale oil production has been up by a hefty 600,000 barrels per day (bpd).

Although there is talk of OPEC seeking to extend the production cuts into the second half of 2017, there is not enough confidence that it will materialise.

Meanwhile, reports of Saudi Arabia producing more oil in January and February than agreed to (10 million bpd) have created additional uncertainty. Also, Iraq is keen to maximise production. Without doubt, production cuts will need more time to work given the inventory overhang that may dissipate over a period of time.

If history is any guide, even in the past, agreements to cut output have fallen apart because every producer wants to retain his market share, not complying with assurances.

The crude market will turn jittery if participants begin to doubt the ability of major producers (mainly OPEC under the lead of Saudi Arabia) to maintain the promised cuts. Speculative investors are also likely to cut their long positions on the back of US producers continuing to boost drilling activity.

So, compliance with the production cut agreement is the key to price stability. While at the moment, if there is a directional change for prices it appears to be to the downside, one cannot lose sight of the upside price risks too. The risk can potentially arise from either demand side or supply side or both.

Supply disruptions

Supply disruptions are not uncommon in the energy market. At the moment, the global geopolitical situation is not strictly unstable; but tension can flare up any time. The demand side looks reasonably healthy with the World Bank projecting global economic growth to accelerate moderately to 2.7 per cent in 2017 after a post-crisis low last year.

The positive relationship between economic growth and energy consumption is of course well established.

The engine of global growth, the US, is performing well (at or near full employment level) while the major emerging markets are also expected to register growth. China is projected to continue with an orderly growth slowdown to 6.5 per cent.

It would be worthwhile to remember that China is slowing from a high base and consumption levels are likely to hold up. Russia, Brazil and India are set to resume growth.

Fortuitously, if demand growth combines with output disruptions, prices have the potential to break upwards and breach the $60 a barrel barrier.

The writer is a commodities and agribusiness specialist. The views here are personal

Related Topics
comment COMMENT NOW