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Abu Dhabi, UAESunday 16 December 2018

Opec exit strategy and electric vehicles to set the energy tone for 2018

Stabilising oil prices have prompted higher output from US drillers

The impact of electric vehicles like those made by Tesla Motors will be limited in the short-term, but will have a longer term impact on oil producers. Brendan McDermid / Reuters
The impact of electric vehicles like those made by Tesla Motors will be limited in the short-term, but will have a longer term impact on oil producers. Brendan McDermid / Reuters

Oil markets can see light at the end of the tunnel in 2018. A year of production cuts by OPEC and its allies has reduced global stockpiles and revived prices. A barrel of Brent crude is now worth almost a fifth more in value than it was 12 months ago.

Stronger demand should help continue the upward trend. But the New Year also brings with it some familiar risks. US oil output is surging and longer term the growth of electric vehicles presents a challenge for fossil fuels.

For the majority of producers in the Middle East, 2018 will be about restraint and agreeing on an orderly exit from their production cut deal. Saudi Arabia - the world’s largest exporter of crude - has held its pact with Russia together against the odds. Both nations agreed last month, along with Opec and their partners outside the group, to extend 1.8 million barrels a day worth of cuts for another year. Despite concerns over compliance, both nations have led by example. The kingdom’s output dropped to a four-month low of 9.97 million bpd last month, while compliance among the 12 OPEC countries with quotas under the extended cuts agreement reached 108 percent.

Moscow is also sticking to its side of the bargain, despite pressure to open the spigots. Output is expected to remain constant in 2018 at just under 11 million bpd. Higher prices help support Russia’s economy ahead of presidential elections in March, which are expected to see Vladimir Putin retain power in the Kremlin. After that, attention may turn to how Russia extricates itself from the deal with Opec without causing a fresh surplus to build up in the market. Concerns over the exit strategy will hang over the market until Opec’s next meeting in June.

“The next important Opec discussion will be an exit strategy from the production cuts, which will likely be the primary topic at the June Opec meeting,” wrote investment bank Jefferies in a research note earlier this month. The bank has raised its price forecast for Brent crude to US$63 per barrel for 2018 from a previous estimate of $57 partly due to the Opec extension and a stronger outlook for demand. Stronger demand could be the final piece of the puzzle for oil markets in 2018. Economies in the G7 industrialized nations are expected to continue to grow steadily over the next 12 months, which will support oil markets. Jefferies has raised its oil demand growth forecast for 2018 to 1.7 million bpd from 1.5 million bpd.

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But stronger demand also brings risks. With Opec and its allies restraining production, US drillers have increased output. US production has soared close to 10 million bpd, and is expected to continue to grow into next year. The Energy Information Administration now expects US output to grow by a further 780,000 bpd next year. But the pace of growth could be tempered by tougher financial realities now being imposed on drillers, which may have to focus more on profitability instead of production increases.

“Concerns still remain with respect to the response of US shale oil to higher oil prices,” said Chris Midgley, global head of analytics, S&P Global Platts. “However, the shale hype seems to be over, with CEOs and management teams being held strongly accountable to deliver positive cash flow over production growth even with oil prices above $60.”

International oil companies (IOCs) may also start to invest in new capacity again in 2018. The collapse in oil prices, which began in 2014, saw dramatic cuts in capital expenditure across the industry. But IOCs have now re-geared their businesses to be profitable with prices even below $50. Jefferies forecasts a 6 per cent increase in capital expenditure by IOCs next year as more major projects gain approval. “Planned capital investments across oil over the next couple of years of around $300bn show that the industry is not underinvesting and is on target. However, these new projects will not emerge until well into the 2020s,” said Mr Midgley.

Finally, 2018 could be a turning point for electric vehicles (EVs). Battery prices are decreasing and major auto manufacturers are ramping up investment into the sector. Toyota - the world’s biggest car maker - said this month that it would pour $10bn over the next decade into the development of EVs and plans to have electric versions of all its vehicles by 2030. The company is targeting 1 million EV sales by the end of the next decade.

“Fears in the media about demand destruction from EVs in the short term are misplaced; and despite impressive growth figures and annual sales likely to head above 1m new EVs a year, this has to be put into perspective with the 80m new cars sold every year,” said Midgley.

Although the growth of EVs won’t immediately turn into demand destruction momentum behind the industry is building. A far bigger concern for oil markets in 2018 will be how Opec and Russia disentangle themselves without triggering another price war.