Oil’s not so well as a slick operator faces fresh challenges

This month has brought both good news and big questions for oil markets.

Brent crude last traded on December 27 at $US68.16 ($97.61).

It has been a difficult time for anyone betting on oil. Climate change threatens long-term demand. In the past year ample production, trade disputes and fears of a downturn have weighed on the price of crude. On December 3, Brent crude fell to $US61 a barrel, 18 per cent below its April high.

Yet by mid-December forces were aligning to support oil prices again. The Organisation of the Petroleum Exporting Countries and its allies agreed on December 6 to lower output by more than 2.1 million barrels a day.

Adding to the optimism, Saudi Aramco, the world’s biggest oil company, listed 1.5 per cent of its shares. On December 12 its market value surpassed $US2 trillion. And on December 13, President Donald Trump announced a preliminary trade agreement with China. That bumped oil prices higher. Brent crude last traded on December 27 at $US68.16 ($97.61).

Even so, oil gamblers are wrestling with two uncertainties. The first concerns US output. The country pumped 17.8 million barrels a day in November, compared with 15.5 million in 2018. But investors have grown impatient with frackers’ meagre profits. The cost of capital for US producers has jumped by about 50 per cent since mid-2016, according to Goldman Sachs. At the start of December 663 rigs were operating in America, about a quarter fewer than a year earlier. US oil output will not shrink in 2020, but its growth may slow. The question is when, and by how much.

The second uncertainty concerns whether members of OPEC’s 23-country alliance will stick to their new deal. The past year gives reason for scepticism. In December 2018 OPEC and its partners agreed to reduce output by 1.2 million barrels a day. Iraq, Nigeria and Russia, among others, have regularly exceeded their limits. To compensate, Saudi Arabia, OPEC’s most powerful member, slashed its own production by an average of 500,000 additional barrels a day, according to the International Energy Agency.

Morgan Stanley estimates that in 2020 1.8 million additional barrels a day will be pumped in countries outside the OPEC alliance, including Brazil, Guyana and Norway. In the run-up to OPEC’s meeting in Vienna in December, it was doubtful whether the group would sustain the cuts agreed to a year earlier, let alone go further.

In the end Saudi Arabia’s new oil minister, Abdulaziz bin Salman, wrangled an impressive deal. The alliance’s 1.2 million-barrel cut will extend to 1.7 million in January. Additional cuts led by Saudi Arabia will push the total to 2.1 million barrels a day. OPEC’s collective output will be 1.3 per cent below its level in November.

It remains to be seen if the cuts will materialise, or last. The new agreement covers only the first quarter of 2020.

Saudi Arabia remains keen to support prices, both for its budget and to make Aramco’s listing a success. The firm’s soaring valuation may not be sustainable. Many investors were repelled by its low dividend yield, security risks and state control. But local retail investors piled in, attracted by the sweetener of a free share for every ten they buy. If Saudi allies fail to stick to their promised cuts, the kingdom will have a choice: slash its own production further or let prices fall. Neither is appealing.