The expected drop in OECD inventories suggests that oil prices will likely be higher in 2018 than originally seen and Brent crude oil price is projected to reach $64 per barrel (/bbl) this year, said the Bank of America Merrill Lynch (BofAML) in a new report.

Put differently, we now expect Brent crude oil prices to average $9/bbl or 17 per cent above last year in 2018, added BofAML in its Global Energy Weekly report.

Opec + Russia could start discussing an exit plan soon

As prices rise, the focus could soon turn to how Opec and the non-Opec deal participants will unwind the production cuts that were agreed to in December 2016. After all, rising prices could soon incentivize elastic US shale supply to come back into the market at an accelerating rate.

“In that regard, we present three possible scenarios for the Opec + Russia alliance to unfold. A first option is that the deal is extended through 2019 or beyond. A second option is that the deal is unwound gradually and the cartel exerts some discipline with only modest increases in supply. A third possibility is a return to another market share war between Russia and the cartel members,” the report said.

A return to another oil market share war is highly unlikely

How likely is a return to a market share war? In our view, this outcome is very unlikely, as it works against the interests of all participants in the deal in the short run. Following two decades of counter-cyclical Opec supply swings to stabilize prices, Saudi Arabian oil production policy turned pro-cyclical in 2014.

Yet the costs to the Saudi treasury have been enormous, with FX reserves falling by 240 billion in the past three years. Having said that, as supply rose, the cartel and Russia gained market share against non-Opec in 2015/16. This situation has reversed with the cuts and Russia and Opec are now losing market share, although higher prices are making up for volumes. So the key question that Opec and Russia have to ask themselves is: what is the revenue maximization opportunity in the oil market?

Gradual approach as Opec prepares to exit

Revenue is of course a function of prices and volumes. If prices climb too much and global supply responds furiously, Opec could end up again in a tough spot. “In our view, a backwardated Brent market with a long-term anchor around $55 to 60/bbl is probably a good outcome for the cartel. Maybe as good as it gets. Should prices rise from there, US shale oil supply could shoot up higher,” said BofAML.

Oil demand could get hurt. So Opec and Russia would probably be better off by signalling a gradual approach or a "tapering" of sorts. Essentially, Opec could signal to the market that production will increase by, say, 40,000 b/d every month unless prices go down significantly. That strategy would keep both spot and forward prices in a range and the crude market in backwardation.

Output from Saudi, Russia, Iraq, and UAE could rise

Still, an expectation of multi-year declines in production ahead will be easily offset by the growth appetite of a few key players. Primarily, Russia has a strong Greenfield oil project pipeline and companies expect to increase output by 1.5 million b/d by 2022, more than offsetting its own older field declines.

On the Opec front, a number of countries in the deal like the United Arab Emirates have been actively investing in new capacity, too and Iran and Iraq both have ambitions to increase output. Saudi Arabia is likely to remain restrained in its expansion of production capacity as prices are probably more important for the kingdom than modest volume growth. – TradeArabia News Service