Published: The Economist
Why oil is at a two-year high
A STRANGE paradox underpins the recent rise in the price of oil to around $60 a barrel, its highest level in two years. On the one hand, it partly reflects optimism that when producers from the OPEC cartel meet in Vienna on November 30th they will extend an agreement with non-OPEC producers such as Russia to keep output under restraint until late next year. On the other hand, it partly reflects the fear that regional tensions between Saudi Arabia and fellow OPEC members Iran and Qatar could degenerate to such a degree that they disrupt supply from the world’s biggest oil-producing region. Such are the tensions within OPEC, according to Reuters, that Gulf oil officials have stopped using a WhatsApp chat group that used to be a useful co-ordination tool. So is it feasible to imagine that people who cannot bear talking to each other via social media can still agree to onerous production cuts that are vital to keeping prices high?
The short answer is yes. Throughout its history, OPEC has awkwardly held together despite intense internal squabbles and even conflicts, such as Iraq’s invasion of Kuwait (both OPEC countries) in 1990. Indeed, one reason for the growing confidence about an extension of the deal due to expire next March is that compliance levels were 96% last month. That is remarkable considering the rising tensions between Sunni Saudis and their Shia foes. Even at the best of times in the past, participants have usually started cheating when oil prices have risen.
Besides OPEC and geopolitics, there are other reasons oil prices are on a roll. A synchronous upswing in the global economy means that demand for oil is rising. The International Energy Agency, a global forecaster, recently spooked the market by saying that higher prices were likely to dent consumption of crude next year. That is possible, but with prices still at less than half their peak of 2008, consumers, such as drivers, show no sign yet of jamming on the brakes. Rising global demand and falling OPEC supply may yet flush out more American shale production, which is the main bugbear of oil bulls. Martijn Rats of Morgan Stanley says that to keep the market roughly in balance, shale-producers will have to raise output from 5.8m barrels a day (b/d) to 6.8m b/d over the next 12 months, a 17% increase. However, he notes that a bottom-up analysis of listed shale-producers suggests their production is only growing at about 5% a year, which is not enough to fill the gap. Rather than continuing to pump as fast as they can, they are now focusing on pumping more profitably.
With Brent crude above $60 a barrel, and America’s West Texas Intermediate drawing close, much of this may be baked into the price. Bullish hedge-fund investment in oil futures is close to record highs. If OPEC and the other petro-states disappoint in Vienna this week, there is the risk of a sharp sell-off. But for the first time in several years, the interests of the biggest producers in keeping output under control may be aligned. Saudi Arabia wants high prices to achieve a generous valuation when it part-privatises Aramco, the state oil company. Russia's president, Vladimir Putin, wants them to keep the economy—and hence his regime—stable. And shale producers want them because their investors are demanding higher returns, rather than higher volumes. No paradoxes there.