The deeper output reduction will have little impact on world oil supply, as the OPEC+ group is already below its agreed supply. The issue is that some members, Saudi Arabia in particular, have shouldered a larger share of the output cut, which has enabled other producers to cheat on their quotas. Getting everyone to comply with the new cut will become the battleground. Unless the cut is extended farther into 2020, the market will fear a supply glut developing in the second quarter, which is the weakest demand period of the year. That will not be good for oil prices.
The media is reporting that to secure the support of Russia, OPEC had to agree to exclude condensate from Russia’s quota. This has been a fast growing component of Russia’s oil exports, something the government is pushing aggressively in order to boost its economy and generate revenues for the government.
The troubling issue for OPEC+ is that U.S. oil production continues to grow. While U.S. E&P companies are being pressured to demonstrate capital discipline in their drilling spending, the slowing of U.S. oil output is only now beginning to be observed. If the OPEC+ agreement lifts global oil prices, will U.S. E&P companies adhere to their capital discipline in 2020? If they don’t, look for U.S. output to resume growing, and oil prices coming under downward pressure.
The physical reality of the global oil market is that increasing the magnitude of production cut for OPEC+ reinforces the view that the world has plenty of supply. This is despite geopolitical tensions, the collapse of Venezuelan output, and the redlining of Iran’s supply. More offshore oil supply is arriving and U.S. shale production growth is only slowing. Unless global economic activity revives, a cosmetic increase in the OPEC+ output cut may not prevent oil prices from falling. Levitating oil prices are at risk of dropping if OPEC doesn’t truly cut its supply.
NATURAL GAS:
Predictions of early cold weather for November, and then again for early December, lifted natural gas futures prices. Temperatures turned out not to be as cold as predicted. They were followed by more mild weather. The result was that gas prices dropped. During this period, gas storage grew as production continued increasing. Storage grew at the same time liquefied natural gas shipments increased.
This year’s storage injection season. which extends from April to October, experienced the second largest increase in the past five years. The 2,569 billion cubic foot storage build was second only to the 2014 increase of 2,727 Bcf. This took gas storage from nearly the bottom of the 5-year average volume to the 5-year average. With the market less concerned about adequate gas for the balance of winter, gas prices have moved lower.
When we examine natural gas prices in 2018 and 2019 compared to gas storage volumes, one sees an inverse relationship in the second half 2019, while there was mostly a parallel relationship last year. The surge in storage recently has convinced gas traders that supply growth is unstoppable, meaning prices do not need to rise to encourage greater gas supplies.
This year has been challenging for natural gas. Gas prices are the lowest they have been in over a decade. In fact, prices are now where they were in the late 1990s. The reason for the low gas prices is that gas supply has overwhelmed demand even though it has grown with the assistance of increased pipeline exports to Mexico and the emergence of LNG exports. As we show, gross gas withdrawals from wells, which includes both all marketable gas plus gas used in well operations, has climbed steadily since 2008 when the gas shale business took off. What is impressive was the jump in gas production in 2018, which continued to increase this year, driven by associated gas from shale oil wells.
When new gas pipelines begin operating, some of this associated gas will be shipped to consumers rather than being flared. The prospect for greater gas supply puts gas prices at risk, virtually regardless of what winter weather and additional LNG exports do. Cheap natural gas will continue to gain market share in the power generation market as it undercuts coal prices. The problem is that electricity demand is growing very slowly, not offering a great outlet for the additional gas supply.
This story was originally featured in ON&T Magazine’s January 2020 issue. Click here to read more.
