Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

The oil market's deus ex machina took the weekend off. For a certain kind of oil company, that is actually a good thing.

The fiasco that was Sunday's Doha freeze-fest dealt a blow to hopes of divine intervention curing the oil market of too much supply. Compared to the OPEC meeting of Thanksgiving 2014, optimism was relatively guarded heading into this confab, which also involved non-OPEC producers such as Russia. Even so, oil prices fell about 6 percent after the meeting ended without a deal to freeze production, before recovering some of that ground.

The meeting didn't establish a freeze. What it did establish -- or re-establish -- was that two of OPEC's big swinging derricks, Saudi Arabia and Iran, are price takers for their oil and want to sell as much of it as they can.

In a competitive market, prices have to fall to a point that deters drilling and stay there for a while to squeeze out some high-cost capacity (and boost demand along the way.)

This is happening already, and a freeze, by rekindling hopes of OPEC saving the day, may actually have been counter-productive. The recent rally had helped struggling U.S. exploration and production firms sell new shares and hedge more of their future output to shore up their balance sheets.

Now, they, their investors and, crucially, their bankers must deal with the financial equivalent of kryptonite: uncertainty.

How uncertain? Well, running the numbers, the outlook for oil supply and demand is best described as: ¯\_(ツ)_/¯.

Even as Doha's proceedings were descending into well-catered chaos, reports surfaced of a massive drop in Kuwaiti output amid a strike. Venezuela, meanwhile, has so far this year burned through more than 40 percent of its currency reserves -- not huge to begin with -- and oil-services giant Schlumberger has announced it will scale back operations there due to unpaid invoices.

Venezuela's Other Reserves
Foreign currency reserves have fallen by 42 percent so far this year
Source: Bloomberg

For every bullish factor, though, there is a bearish counterpart. Iran and Saudi Arabia aren't the only ones who may raise production through the rest of 2016; Libya and Iraq could also add to the glut. Meanwhile, on the demand side, the IMF is once again sounding the alarm on economic growth, which detracts somewhat from the strong numbers on oil consumption in countries such as the U.S. and India.

The International Energy Agency's latest projections, assuming OPEC output stays flat at first-quarter levels, imply the global glut of oil inventories should start to shrink in the third quarter. But it is easy to construct bull and bear cases around that.

On the optimistic side, say no OPEC member manages to raise output and that Kuwait's strike takes 1.6 million barrels a day offline for a whole quarter and that Venezuela's output drops by 1 million barrels a day across the second half of the year. Add an extra 200,000 barrels a day of demand for good measure.

For the bears, assume Iran's output climbs to 4 million barrels a day by the end of the year and Saudi Arabia adds 1 million a day of its own by then. Libya and Iraq, meanwhile, add a further 750,000 barrels a day between them. Kuwait and Venezuela hold it together. Demand, however, is 200,000 barrels a day less than forecast through the rest of 2016.

Here is what that looks like in terms of the world's excess or deficit of supply.

Big Enough for a Supertanker
The range of outcomes on the gap between global oil supply and demand through the rest of this year is very wide
Source: international Energy Agency, Bloomberg Gadfly analysis
Note: Bull and bear cases as per assumptions detailed in the column.

At the extremes, those cases are likely the difference between oil ending the year north of $60 a barrel or south of $30. The actual outcome will probably be somewhere in between. The point is that no one knows.

This is bad for any oil producer, but worse for those with too much debt who rely on the good graces of creditors and investors. Those producers have performed best since talk of a supply freeze first surfaced in February.

We Heart OPEC
Freeze hopes have benefited the highly-levered sectors of the oil industry but not the likes of Exxon Mobil
Source: Bloomberg
Note: Indexed price performance.

Notice how Exxon Mobil has barely budged. This isn't too surprising for the Big Oil stock -- it rarely gets the same pop from rising oil prices that its smaller brethren enjoy. Equally, though, it should weather what is likely to be a volatile few quarters in the oil market now that OPEC's cavalry is charging at itself rather than to the rescue.

Indeed, Exxon should be glad Doha didn't deliver. For one thing, it can hope that weaker petro-states will be forced to soften the resource nationalism that has kept western oil majors away from reserves on economic terms for much of the past decade or so. Even Saudi Arabia is considering radical economic reforms.

More tangibly, Exxon has acknowledged it is looking at possible acquisitions, but says potential targets have unrealistic expectations on price. Those expectations may well soften now that hopes of OPEC and Russia putting a floor under the oil price have been dealt a big setback. 

With an OPEC meeting scheduled for June, expect oil ministers to once again talk up hopes of a deal. That would count as a genuine miracle at this point and, as such, should be discounted. After this weekend, the market, with all its attendant uncertainty, rules.

As and when oil prices take a periodic nosedive, Exxon's chances improve of finally getting a target to capitulate. Indeed, when that happens, it'll be a reasonably good sign that a sustainable rally, not one based on ministerial mutterings, is underway.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net