The last time OPEC met on Thanksgiving Day

Fadel Gheit, Managing Director, Oil & Gas Senior Analyst at Oppenheimer & Co, on oil

The last time OPEC met on Thanksgiving Day, the group said it would not cut production to offset new supplies from the U.S. Since then, oil prices have plummeted by 30%. They have lost half their value since the middle of last year. This is hurting some oil producing countries more than others. Is there a chance of a change in OPEC policy any time soon?

I do not expect any change in OPEC production policy, since Saudi Arabia is the de-facto leader of the cartel. The low oil prices have forced all oil producing companies to cut capital spending and reduce operating costs, which will reduce production, balance supply and demand and lift oil prices going forward. We expect shale oil production to slow down and begin to decline later this year and into next year. Therefore, Saudi Arabia would be able to achieve its goal of taking marginal oil producers out of the supply chain.

A growing number of OPEC officials are making cautiously hopeful comments on the demand outlook. This week, Saudi oil minister Ali al-Naimi said demand was growing, while a Gulf OPEC delegate said it would rise more strongly in the second half of 2015. What are your thoughts on the oil demand prospects?

We expect global oil demand growth to continue, albeit at a much slower pace because of improving efficiency, switching to renewable fuels, and growing environmental concerns. We expect annual demand growth of less than 1%.

Oil edged up last week towards $62 a barrel as expectations of a coming recovery in global demand countered a further jump in U.S. crude stockpiles which underlined the currently ample supplies. Do you believe this is a rebound before an even sharper drop?

I do not expect a sharp drop, but do not rule out a pullback as Brent prices have surged by more than 35% in the last two months, but WTI gained less than 15% because of the continued oversupply in the US. We expect oil prices to remain volatile and unpredictable, but they will show a positive trend as the supply and demand get more balanced.

We expect oil prices to remain volatile, but it will ultimately reflect the action by OPEC, primarily Saudi Arabia and other Gulf states, regarding the production policy. It is important to realize that Saudi Arabia knew that without a large production cut oil price could sink below $40/b for a brief period, which is exactly what happened. Saudi Arabia is losing about $250 million/day in oil export revenue and OPEC is losing $1.2 billion/day. The decline in annual oil export revenue would be $90 billion for Saudi Arabia and more than $430 billion for OPEC.

Why would Saudi Arabia allow oil prices to crash and hurt it is own financial interests, unless it was the only way to curtail marginal oil production, mainly in North America? This strategy of letting oil prices drop sharply seems to work as oil companies have cut capital spending sharply. As a result, we expect oil production to flatten then begin to decline during this year and into 2016.

We believe the oil shell technology is here to stay, and continued efficiency gains will help reduce the break-even point and allow shale oil producer to be more resilient to low oil prices. We believe $70 oil is the new $90 oil. A combination of lower cost structures and rising oil prices will help unconventional oil production in the US and Canada to stabilize and even grow at lower oil prices, albeit at slower rates. However, if oil prices do not rebound above $70 Brent, we think non-OPEC oil production will be flat or decline. Saudi Arabia is stimulating market rebalancing, acting as a catalyst, to quickly induce without interfering directly into the marketplace, with their inaction bringing some structural changes into the oil markets.

Most of the US oil producers have reduced their recount significantly over the last six months, whereas the trend itself continues — obviously, at a slower pace. Most of the cuts have been announced and implemented. Nevertheless, it is impossible to imagine the US Shell production would continue to grow in light of 50% drop in the rig count. Eventually, unconventional oil production will taper off in terms of growth and then decline. Henceforth, the Saudi Arabia would have achieved its goal by late this year or early 2016. But, we think a rebound in oil prices to the $80-$100/b range is unlikely in the next three years. And, as oil prices recover, so will unconventional oil production, which would repeat the oil price cycle and OPEC would have a much bigger long-term problem with oil sands and oil shall producers.