OPEC
OPEC

Many agricultural prices remain under downward pressure from record stocks accumulated through successive bumper harvests

COMMODITY PRICING

Global oil prices are likely to remain volatile in the remainder of 2017, as conflicting factors—such as rising US shale production and higher geopolitical risk in the Middle East—pull the market in different directions. OPEC members and their partners, notably Russia, have extended their existing production-cut deal until end-March 2018. Although OPEC’s compliance with the new quota system reached a record level of 96% on average in January-May 2017, the most recent data from the International Energy Agency show that several countries exceeded their target in June—including Saudi Arabia, which hitherto had been making deeper than expected cuts in order to compensate for weaker compliance elsewhere. This raises a downside risk that countries will allow their adherence to slip over the course of 2017, in an attempt to boost their oil receipts. Nonetheless, we still expect OPEC to maintain restraint—even the June compliance rate of 78% is far above those seen in previous attempts to restrict supply—as member countries seek to avoid a renewed price crash. This is particularly true as output from non-OPEC countries rises steadily. Russia continues to abide by its promises for now. Its output in June was down by 280,000 barrels/day (b/d)—nearly 100% of its pledged cut—albeit from a record-high baseline of 11.6m b/d set in October 2016.

Overall, OPEC producers have shifted to a more pragmatic approach, in which they will continue to exercise restraint in order to bring about a modest, and very gradual, market rebalancing. If participants were to abandon the agreement in 2017, before global supply begins to tighten noticeably, this would bring around 1.8bn b/d in currently frozen production back on line quickly. This could cause prices to plummet back down to the low of US$30/barrel seen in 2016. The Economist Intelligence Unit remains of the view that OPEC producers would not be willing to accept this outcome, particularly as Saudi Arabia seeks to bolster oil prices and, by extension, the valuation of the state-owned oil firm, Saudi Aramco, ahead of the sale of up to a 5% stake in the company in 2018. As a result, we expect the deal to be unwound gradually, probably around the third quarter of 2018. This will allow for a more orderly end to the agreement, avoiding a disruptive market crash. Important downside risks remain; most notably, if some participants chose to abandon the deal abruptly, seeing it as a failure, this could push other members to do the same, which would push prices down quickly.

OPEC’s new-found restraint has yet to have the desired impact on prices. This is largely because of the development of the US shale sector. Unlike in OPEC, there is no mechanism for strategic, collective decision-making among US oil producers, meaning that US output is driven solely by market forces. In the past six months, with global oil prices hovering above US$50/b, this has been encouraging for US shale investment and output. Accordingly, monthly data from the US Energy Information Agency showed that total crude output had reached 9.1m b/d in April 2017; this is slightly below the level seen in the more frequent, but also more volatile, weekly statistics, implying that US crude output may not be rising quite as fast as previously expected. Nonetheless, it is still up by 1.5% year on year, and we expect production to rise by 6% in 2017 as a whole as investments made in the first half of the year begin to pay off. At end-June the US oil rig count, compiled by Baker Hughes, was up by 116% year on year, at 952 active rigs. This will drive a steady expansion in US output until the first quarter of 2018 at least, which will act as a dampener on prices throughout the year.

Other than rising output from the US, the main obstacle to market rebalancing has been modest global consumption. We expect global oil demand to expand steadily, at an average of 1.4% per year, in 2017-18, but this will be too slow to make a major dent in global stocks. As a result, we expect the global oil market to register a small deficit, of just 40,000 b/d, in 2017, but to return to surplus in 2018 as countries gradually seek to regain lost market share, and as output continues to rise from Nigeria and Libya, both of which are exempt from the OPEC quota system. Overall, the global oil story has shifted to one of stagnation rather than recovery. We expect the price of dated Brent Blend, the international benchmark, to rise to an average of US$52/b in 2017 as the market registers a small deficit, before inching back down to US$50.8/b in 2018 as the OPEC deal slowly unwinds and as demand slumps in the second half of the year—particularly from China. We expect Chinese consumption to soften in line with an abrupt slowdown in industrial production and investment growth there, which will have negative knock-on effects on other economies in the region. We expect prices to rise marginally in 2019, to US$53/b, as rising production costs weigh on output in the US and global stocks begin to tighten. We forecast prices to firm slightly, reaching US$58.8/b by 2021, supported by an improvement in global economic growth and slower increases in OPEC production.

Rising political tension among the Gulf Co-operation Council (GCC) countries—illustrated by the Saudi-led embargo of Qatar that began in June—has the potential to influence global energy prices in several ways. The possible impact on crude oil prices is fairly low; any disruption to Qatar’s exports is unlikely to push up global prices, as Qatar is only a minor producer of crude oil. Deteriorating relations between countries across the GCC (and possibly involving Iran, which maintains closer ties with Qatar) could potentially undermine OPEC countries’ willingness to work together to rebalance the global oil market, which could cause the OPEC deal to be abandoned and put downward pressure on oil prices. However, we still consider this scenario to be very unlikely, as any disruption to oil prices would have a particularly negative effect on Saudi Arabia, the region’s main crude oil producer. A more significant risk applies to the liquefied natural gas (LNG) market. Any disruption to regional trade flows would be likely to cause LNG prices to spike, as Qatar accounts for roughly one-third of global LNG production. However, we consider it to be highly unlikely that GCC countries would enact a full blockade, as many countries—primarily the UAE—rely on Qatar for their own LNG supply.

After years of oversupply and falling prices, tightening supply-demand balances have triggered rapid increases in the prices of several commodities. However, the rebalancing process is far from complete, reflecting a sluggish supply response to low prices (mostly related to producers cutting costs), and, for some industrial commodities, insufficient demand from China. We believe that in 2017-21 the prices of many industrial and agricultural commodities are unlikely to break away from recent lows. For those that do see substantial growth in 2017—particularly base metals—this is unlikely to be sustained in 2018 as China’s economic slowdown takes hold. Many agricultural prices remain under downward pressure from record stocks accumulated through successive bumper harvests.

Hard commodities: Industrial raw materials (IRM) prices remain volatile, but we expect the prices of all six base metals that we track on the London Metal Exchange (LME) to rise in 2017, the first such co-ordinated increase since 2011. The rise will be driven by recovering demand across emerging markets—including in China but also from India—and further supported by higher global oil prices compared with 2016. However, IRM prices will contract slightly in 2018, as weaker demand from China—particularly for metals such as copper and aluminium, for which China’s relative weight in global consumption is greatest—offsets demand growth elsewhere. On balance, we expect industrial commodity prices to rise by 16.2% in 2017, driven largely by the sharp rise in the price of base metals as markets tighten, before falling back by 0.8% in 2018.

Soft commodities: We expect food and beverage prices to remain relatively flat over the forecast period, reflecting subdued demand (in historical terms), record-high inventories following bumper harvests and several large grains outturns in the 2016/17 season. Despite concerns that another potentially disruptive El Niño weather event could be gathering on the horizon, this remains an outside risk, and we do not forecast an agricultural price shock in 2017‑18. We forecast the food, feedstuffs and beverages (FFB) price index to contract by 0.3% in 2017 as higher than expected production of several goods, primarily sugar and cocoa, further inflates large global stocks. Unlike IRM prices, agricultural commodity prices will return to growth in 2018, of 1.9%, underpinned by rising populations and incomes, as well as rapid urbanisation and changing diets. However, price growth will be limited by ample stock availability.

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