In the first two months of 2017 OPEC members have demonstrated an unprecedented level of compliance with the production cuts agreed in late 2016.
This marks a major reversal of the “free-for-all” market-share strategy that Saudi Arabia and other Gulf Arab states had adopted in 2014 as they sought to combat the rise in US shale production, which had weakened OPEC’s share of global output. Data from the International Energy Agency (IEA) show that OPEC members met 90% of their pledged production cuts in January and February, with Saudi Arabia cutting its output even further than promised in order to compensate for weaker compliance elsewhere. For the duration of the six-month agreement, OPEC members plan to trim crude oil output by about 1.2m barrels/day (b/d) from October levels to 32.5m b/d, extendable by another six months. The pain is designed to be shared equally: most OPEC members are to reduce output by around 4.6%. However, Nigeria and Libya are exempt, and Iran was granted a 90,000-b/d increase in its quota from October production levels. Boosting the deal’s impact, a group of 11 non-OPEC producers agreed to join the effort, reducing output further by a combined 558,000 b/d. Around one-half of this total is meant to come from Russia.
The immediate, sentiment-driven boost to prices stemming from OPEC’s commitment has largely been sustained. In December, following the announcement of the deal, the price of dated Brent blend jumped above US$55/barrel for the first time since mid-2015. Since then, however, prices have largely remained within a tight band of US$55-57/b, as the impact of OPEC’s restraint was partially offset by other factors, particularly from the US market. We now expect US crude oil production to rise by 2.8% year on year in 2017 (from 1.5% growth previously). The sustained rise in prices in late 2016 and early 2017 has encouraged US shale drillers, pointing to a revival (the US oil-rig count, compiled by Baker Hughes, jumped from a low of 316 active rigs in May 2016 to 756 on March 3rd). The prospect of higher US shale oil output, coupled with above-average crude stockpiles in the US—which have built rapidly in recent weeks, despite only modest consumption—will limit faster price growth in 2017.
The Economist Intelligence Unit nonetheless remains of the view that annual average oil prices will be higher in 2017 than in 2016, driven by a modest rebalancing of the oil market. Greater OPEC restraint will be the primary factor in this rebalancing. The prospect of a sharper than expected rise in US shale production in late 2017 is a key downside risk to the forecast, as higher market supply would erase recent price gains. OPEC producers, led by Saudi Arabia, opened talks with major US shale producers in early March, in an attempt to reach consensus on the need to moderate production growth. For now, we believe that OPEC is likely to extend its production cut agreement by another six months in order to complete the market rebalancing and sustain price growth; however, if US producers are perceived to be taking advantage of higher prices created by OPEC restriant, the deal could fall apart later in 2017.
In addition, we remain skeptical that other non-OPEC producers will fully respect their commitment to lower their production quotas. Russia’s offer was vague and came with caveats. In contrast to its counterparts in many OPEC countries, the Russian government has no established mechanism for restricting oil output, and senior figures in the industry are known to be opposed to cutting production. Russia pumped almost 11.5m b/d in January 2017, 100,000 b/d fewer than in December, but it remains unclear whether this was because of compliance with the OPEC deal or a consequence of the cold winter weather making operating at capacity impossible. Considering production more broadly, a number of new oilfields are due to come on stream in 2017, which, all else being equal, will push production higher.
The lack of policy clarity under the new US president, Donald Trump, is also a key risk to our price forecast. Energy policies in the US that favour domestic oil producers may, by boosting supply, exacerbate downward pressure on prices. However, if Mr Trump chooses to take the US out of the 2015 Paris Agreement on climate change (or merely disregarded its targets), stronger demand for fossil fuels would be supportive of oil demand, and therefore prices. A relaxation of sanctions against Russia would be a gift to its oil producers, but the impact on global supply could be offset by a reintroduction of sanctions on Iran.
The price rally will lose steam in 2018 as some countries ease their production limits in order to take advantage of higher global prices, leading to an unravelling of the OPEC deal. In addition, we expect Chinese consumption to soften in line with an abrupt slowdown in industrial production and investment growth there, which will have negative knock-on effects on other economies and weigh on sentiment globally. As a result, we expect Brent prices to rise only modestly, to an average of US$60/b in 2018. These will fail to rise much higher in 2019‑20 amid continued output growth from OPEC countries and, in 2019, a recession in the US. Prices will begin to edge up only in 2021, rising to US$64/b. Steady demand growth and slower increases in OPEC production will provide support, and the effect of several years of low investment will be felt more markedly in higher-cost producers.
After years of oversupply and falling prices, tightening supply-demand balances have triggered rapid increases in the prices of several commodities. However, the rebalancing process is far from complete, reflecting a sluggish supply response to the low price environment (mostly related to producers cutting costs), and, for some industrial commodities, insufficient demand from China. We believe that the prices of industrial and agricultural commodities are unlikely to break away from recent lows in 2017-21; for those that do see substantial growth in 2017, this is unlikely to be sustained in 2018 as China’s economic slowdown takes hold. Many agricultural prices remain under downward pressure from record stocks accumulated through successive bumper harvests.
Hard commodities: Industrial raw materials (IRM) prices remain volatile, but we expect the prices of all six base metals that we track on the London Metal Exchange (LME) to rise in 2017, the first such co-ordinated increase since 2011. The rise will be driven by recovering demand across emerging markets—including in China but also from India—and further supported by higher oil prices. However, the tide will turn again in 2018, especially for metals that are most vulnerable to China’s investment and industrial cycles and for which China’s relative weight in global consumption is greatest, such as copper and aluminium. On balance, we expect industrial commodity prices to rise by 14.8% in 2017, driven largely by the sharp rise in the price of base metals, as markets tighten and stocks are gradually worked through. Prices will drop back in 2018, by 5.8%, amid falling demand from China.
Soft commodities: Despite the negative impact on output of El Niño- and La Niña-related weather disruptions in 2015-17, we do not forecast an agricultural price shock. This reflects subdued demand (in historic terms), record-high inventories following several bumper harvests and several large grains outturns in the 2016/17 season. Nonetheless, our food, feedstuffs and beverages (FFB) price index will rise by 3.4% in 2017 as global wheat prices return to growth and sugar prices rise more sharply. Unlike IRM prices, agricultural commodity prices will remain on a modest upward trend in 2018, despite the economic problems in China, underpinned by rising populations and incomes, as well as rapid urbanisation and changing diets. However, price growth will be limited by ample stock availability.