Opec step to cut production will raise prices and spur Kenya oil investments

At their meeting on November 30, the Organisation of Petroleum Exporting Countries (Opec) members reached a firm agreement to cut future crude oil production by 1.2 million barrels per day (bpd) to a total ceiling of 32.5 million bpd effective January 2017.

A committee of three members was tasked to monitor compliance, with a review in six months time.

The meeting also exempted Nigeria and Libya from production cuts as they recover from impacts of internal disturbances. A critical success factor was the expression of commitment by a number of key non-Opec producers, including Russia, to participate in production cuts.

As anticipated, the petroleum exporters’ agreement immediately pushed up Brent crude oil prices by as much as nine per cent to between 53-54 US$ per barrel.

Crude oil prices had since mid 2014 dropped from more than $100 to a low of US$25 early this year, before rebounding to just below $50. The price collapse was caused by an over-supplied global market with subdued demands.

Since last week, market reactions and speculation have essentially set up a new baseline price range of US$ 50-55 per barrel within which prices are expected to oscillate depending on how Opec members implement their reduction commitments.

This time around, not complying with cuts is not likely to be an option for the membership, advised mostly by the high stakes in their national budgets.

Short term, it is the USA shale oil producers who are the major sensitivity and uncertainty, as these will most likely increase their production in response to the high prices resultant from the Opec agreement.

The shale investors have over the last two years developed operational flexibility which enables them to quickly increase/decrease investments and production in response to global oil markets.

The group’s production reduction plans may also be neutralised by new oil coming into the market from newly matured production projects across the world.

A good example is the new oil from Ghana and also elsewhere in the non-Opec world. However, this may be offset by reduced supply from production projects delayed or cancelled over the past two years.

The “demand barrel” may also be taking a slimmer shape due to the ongoing demand attrition especially in China and Europe.

There is increased talk of a looming “demand peak” as oil demands increasingly convert to renewable energy (and natural gas ) and as energy efficiency gains momentum in all economic sectors.

In summary, it is the net effect of supply reduction by Opec (and their co-operators); increased supply from US shale fields and elsewhere; and reduced market demands that will determine future price levels.

At the end, it is the amount of surplus oil sitting in storage tanks that impacts prices.

We should also not ignore the strong influence of commodity speculators on global oil prices, and these will definitely be “talking up” the prices at the slimmest of market influences.

My guess is that despite the recent Opec agreement, prices will most likely not increase above $55 over the next six months.

However, no one should underestimate the new resolve by Opec members to reinstate the true value of their oil. That, in a way, may mean leaving as much oil in the ground as is necessary to harden prices, instead of giving oil away at throw away prices.

There is an apparent newly found Opec unity of purpose to influence the destiny global oil markets after nearly 30 months of dramatic socio-economic downturns in their countries with diminished budgetary capacity and mounting debts.

This has prompted various structural adjustments in their policies, especially in respect of economic diversification.

What does all this mean to Kenya? Sustainably high prices above $50 will certainly trigger renewed but cautious interest and action towards increased upstream spending.

It is understood that the Turkana oilfield investors are already planning to resume exploration and appraisal drillings.

This has the effect of potentially increasing confirmed reserves beyond 1 billion barrels which is necessary for improved economics in respect of field and pipeline investments.

Further, the higher the realisable oil prices the quicker will be the final investment decisions.

Apart from Turkana oil basins, I see upstream activities in other unproven exploration basins remaining subdued and low-key for some time to come unless oil prices sustainably shoot above $60.

As crude oil prices continue to climb above $50 we expect to see products pump prices passing the magical figure of Sh100 per litre, aided also by the tax increases implemented a number of months ago.

And this will trigger direct and indirect inflation.

Wachira is director of Petroleum Focus Consultants. [email protected]