The cure for low prices

Author James Gooder, Vice-President, Crude Oil

The oil market is oversupplied, prices are low and producers are fighting to undercut one another to hang onto market share.

The oil market is oversupplied, prices are low and producers are fighting to undercut one another to hang onto market share.

Leading industry figures have gathered in Geneva for the annual Argus European Crude conference. The event has become a key part of Geneva’s equivalent of London’s International Petroleum Week.

In the year since the last event, the price of Brent crude has fallen from close to $90/bl to $50/bl, Opec has adopted a Saudi-led laissez faire policy, and the agreement to lift sanctions against Iran has raised the likelihood of a steep increase in exports next year. It was a very profitable summer for refiners, boosted by gasoline demand in developed economies. But, having produced flat out to meet gasoline demand, refiners have created a large surplus of diesel, which now threatens to blunt any price recovery in the near term.

The low prices are pushing some upstream companies to clip their exploratory wings, and this may be storing up a supply crunch in the years to come.

In the North Sea, production declines have halted after investments made when prices were above $100/bl to prolong the life of ageing fields. If this spending dries up now, the return to downward output momentum is inevitable.

Several speakers in Geneva noted the falling rig count in the US shale areas. The explosive production growth from US shale areas over the past couple of years has surely come to a halt. Opinions vary on whether this halt to output growth will lead to a swift drop-off or the start of a plateau. Much depends on prices.

One speaker at the event noted that there is no better cure for low prices than a period of low prices. Low prices reduce investment and encourage consumption, and oil markets will surely rise again.

Benchmark brinksmanship

Another of the key themes at this year’s event has been the fitness for purpose of existing price benchmarks. The North Sea Dated complex is in good health, because quality premiums are creating more liquidity in the trade of BFOE grades and, thus, more information underlying the benchmark.

Discussions have intensified on whether the North Sea basket should be expanded to include Russian Urals, the largest flow of spot-traded crude to Europe, or light grades from further afield, such as Algerian Saharan Blend, Nigerian Qua Iboe or Azeri Light. One speaker described such developments as “putting lipstick on a pig”, although others said it is a simple matter of mathematics.

In the North Sea, the Johan Sverdrup development remains on target to bring an additional 500,000 b/d to market in late 2019, despite the fall-off in regional upstream spending. Some say it could be added to the BFOE complex, despite its higher density than the current grades.

Producers say they are under-represented in the current pricing processes. Promoters of Russian Urals as an independent crude benchmark argue that it is an obvious alternative to the increasingly Byzantine BFOE system. Another speaker described continuing to price Urals against North Sea Dated or Dated Brent as “a dead end”.

Further east, weaknesses in the Dubai pricing system were exposed by high levels of anomalous trade between Unipec and China Oil during August, which has concerned those Middle East producers that are attempting to set term contracts against Dubai.

There is an urgency to discussions about how to maintain and improve crude benchmarking east of Suez.

In the ongoing war of the benchmarks, the next battle will be fought over Dubai.