The surge in U.S. tight oil supply from about 44 thousand barrels per day (bpd) in 2006 to about 1.7 million bpd in 2014 accounted in the main, for the massive global crude oil supply imbalance that exceeded 2 million bpd in 2015. Global crude oil prices plummeted from more than US$110 per barrel in 2Q 2014 to just under US$30 per barrel in 1Q 2016. The production accord reached in November 2016 between members of Organization of the Petroleum Exporting Countries, OPEC, and other oil producing countries, twenty-four in all, was aimed at reducing that imbalance by reining-in about 1.8 million bpd of production.

Crude oil prices have risen by more than 150% since then, reaching near four-year highs over the past few days and even the two largest producers, Saudi Arabia and Russia have been talking up a rollover of the production cuts.

Fundamentals

OPEC, over the years, had difficulty with adherence to production quotas and so there were initial concerns about the ability of participating members to meet reduction quotas as provided for in the accord. Those concerns proved unfounded as aggregate compliance in March stood at 163% according to the International Energy Agency, IEA. The compliance rate for participating non-OPEC producers was 90%. The production accord eliminated 2.4 million bpd from the global output.

This high compliance rate may have been boosted by accidental or unintended supply cuts. For example, socio-political unrest in Venezuela, a member of OPEC boasting the world’s largest proved oil reserves, saw production in that country fall to a near thirty-year low, lopping off about 580 thousand bpd in March over year-ago levels. The net loss was about six times the country’s reduction quota provided for in the accord.

Angola presents another example. Since the peak output at about 1.9 million bpd in 2008, production has been declining due mainly to underinvestment in offshore fields as well as high decline rates associated with the producing formations.

Crude oil demand has also been trending higher, driven by a sluggish price recovery and a global economic ─ even if gradual ─ rebound. The result is a near-balance of the market.

The Middle-East and North Africa (MENA) region accounted for about a third of global oil supply in 2017 and any crisis arising therein will surely unsettle global markets. The long-simmering rivalry between regional giants Iran and Saudi Arabia is currently boiling over as a proxy war in the Yemeni crisis. Drawn by a seemingly urgent need to overcome a common foe, Saudi Arabia and Israel have formed an alliance of sorts. The recent decision by United States president, Donald Trump to

 and re-impose sanctions on Iran has only exacerbated the conflict; just hours after the announcement of that decision, Israeli and Iranian forces exchanged robust missile fire across the Golan Heights, in what many analysts believe is 

If and when U.S. sanctions on Iran come into effect, as much as 500 thousand bpd of Iranian oil supply could be taken off the market. And with the sustained accord production cuts, prices would most probably spike. The effect across several sectors of the global ─ and particularly U.S. ─ economy would be deleterious. For example, the summer driving season in the U.S. is just around the corner, as is the peak air travel period. Higher fuel prices would definitely add to transportation costs and this could be significant in an election year.

It is often proffered that higher oil prices would bring more U.S. shale supply to the market. While oil output from shale formations in the U.S. has certainly been on the rise, infrastructural, operational and structural constraints limit the ability to bring all such to the market. In the prolific Permian basin for example, pipeline capacity shortfalls, labor and equipment inadequacies, as well as increasing complexity of shale projects, have presented challenges to maximum benefits from the oil price spike. Just recently, deliveries at Cushing, Oklahoma, the U.S. distribution hub were sold at discounts as much as US$12.50 per barrel, as reported by Bloomberg.

Crude oil prices have only risen marginally in the wake of these developments, probably because risk assessments were already factored in. However, British and European equity funds have been beneficiaries.

Outlook

The International Energy Agency, IEA, expects non-OPEC crude oil output for the year to increase by 1.8 million bpd, but adds that even that figure will be insufficient to meet the rising demand. Higher oil prices will inevitably conduce to lower demand, a situation that suits neither producer nor consumer. Perhaps driven by this, Saudi Arabia and Russia, two of the world’s largest oil producers and principals in the production cut accord, are interested in maintaining a balanced oil price, even if for different reasons.

Saudi Arabia, in accordance with her aggressive economic restructuring vision, is preparing its state oil company, Saudi Aramco for an IPO. The country expects a multi-trillion-dollar return, which would be facilitated by higher oil prices. The Russian economy, on the other hand, has been battered by a series of Western sanctions and the country would be relieved by the current spike in oil prices.

These two countries seem poised to influence oil supply ─ and therefore price ─ in the near-term. Among OPEC producers, only Saudi Arabia boasts any significant spare output capacity; Venezuela, Angola, Nigeria, Iraq and Libya all have output issues, with Iran bracing for acute sanctions that would curb output.

For U.S. shale producers, mixed hedging prospects in addition to the afore-mentioned constraints, would limit their ability to present a significant supply to the market in a timely manner.

Current concerns for global oil supply are focused in the main, on looming tensions in the MENA region, but also on output from countries outside the Organization for Economic Cooperation and Development, OECD. Many of the major oil producing companies have significant exposure to non-OECD countries. Total, for example has a 77% production exposure to non-OECD countries. In the MENA region, its exposure is 22% and for Eni and BP, the values are 40% and 16% respectively.

Delivery costs for many new deep-offshore prospects are rapidly approaching breakeven parity with some shale operations, even as the latter are gradually progressing to more structurally complex ─ and potentially costlier ─ acreages. However, due to longer development periods and market uncertainties, some of these deep-offshore prospects have been shelved. With rising demand projected to hold steadily, this could set the stage for an oil price shock in the medium to long-term.