Saudi Arabia's former minister of Oil and Mineral Resources, Ali al-Naimi, arrives for an OPEC meeting in the Qatari capital of Doha on April 17, 2016. AFP/Karim Jaafar
Less than two months after a surge in the oil price sparked optimism that the market had bottomed it has abruptly crashed again to levels last seen four months ago.
Brent crude prices have now fallen almost 20 per cent since their recent peak in early June. They slid more than three per cent overnight, to $US42.14 a barrel, after Saudi Arabia cut prices for Asian buyers in what appears to be a new phase, and a new front, in a market share war it has been waging for two years.
When OPEC, led by the Saudis, began to lift its production in 2014 and punctured a boom in oil prices that saw them peak close to $US115 a barrel, its primary target was seen to be the then-booming US onshore oil industry.
While it has had an impact, OPEC’s near record levels of production have had less of an effect of US production than had been anticipated.
While it has knocked out about a million barrels a day, the impact of the dramatic fall on prices has been to ignite an equally dramatic fall in production costs, a rise in the productivity of US shale oil and it has lowered break-even points to such an extent that the number of rigs operating onshore in the US has been rising steadily over the past two months.
The Saudi decision to drop prices and raise production appears to be directed at a different target.
The spike in the oil price from its lows of less than $US30 a barrel in January to $US52.51 a barrel in early June was aided by supply disruptions in Nigeria and Canada. The price has subsequently fallen back as Nigeria, Russia, Iraq, Libya and Iran — and the Saudis — have lifted their output.
It may be the re-emergence of its arch regional rival Iran as a major producer after its years of sanctions that has pushed the Saudis into action again. Iran is steadily lifting production towards its target of 4 million barrels a day, with a 25 per cent increase in volumes this year.
The recent strength of the US dollar may also be influencing the price, given the inverse relationship between the dollar and oil prices, but the fundamentals appear to be the driver and, with global inventories bulging — US inventories of crude are about 100 million barrels above their five-year average — there is a glut of supply.
The underlying fundamentals, however, remain encouraging.
The collapse in the price since 2014 has seen well over $US1 trillion of planned exploration and development of new supply abandoned even as demand has been rising modestly but steadily.
It is the glut of stocks of crude and of refined product that will have to be worked through before the fundamentals of supply and demand eventually reassert themselves.
The industry expectation remains that sometime next year, probably in the second half, the market will be in a far more balanced position and that the price will firm significantly to levels between $US60 and $US70 a barrel.
The wildcard, however, is the actions of the Middle East producers and the Saudis in particular. If OPEC production remains at near record levels and the Saudis remain more concerned about market share than price, the stability and price levels the industry needs before investment in exploration and development can recover might remain elusive.
While the oil price has fallen as the US dollar has risen, iron ore prices — which generally have the same inverse relationship with the dollar as oil — have been rising strongly, pushing past $US60 a tonne overnight.
The divergence appears to be driven by the strong levels of activity in China’s steel sector, probably because of the underestimated impact of China’s attempts to stimulate its economy through another wave of infrastructure investment.
Another factor may be the decline of China’s domestic iron ore producers, displaced by low-cost and higher-quality seaborne iron ore.
The recent filing of an anti-dumping complaint by more than 20 Chinese domestic miners was a signal that the pressure on those producers has become acute as they lose both market share and actual volumes to imports from Australia and Brazil.
There is also structural change occurring within China’s steel industry and resource sector, with the authorities trying to drive out uneconomic capacity.
With a significant proportion of China’s domestic iron ore production integrated with local steel producers, the emphasis on fewer, larger and more efficient mills would have a disproportionate impact on the domestic miners and could boost demand for the higher quality ore imports.
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