Oil prices have traded reliably in the $50s per barrel since OPEC agreed to cut production last November, but having failed to break through a ceiling in the upper-$50s, crude prices are in danger of falling back again.
The oil market had wind in its sails on expectations of substantial drawdowns in inventories following the pending cut of a combined 1.8 million barrels per day (1.2 mb/d from OPEC plus nearly 0.6 mb/d from non-OPEC countries). Indeed, the IEA reports that oil inventories in OECD countries have declined for five consecutive months, although they still stand above the running five-year average. Meanwhile, in the U.S. oil inventories have actually increased significantly so far in 2017.
The shockingly high compliance rate that OPEC has thus far achieved this year, one would think, should have pushed oil prices up much higher. But crude prices have barely budged since several key market watchers, including S&P Global Platts, the IEA and OPEC, put out similar numbers that show OPEC countries have achieved a roughly 80 to 90 percent compliance rate, much higher than analysts thought would be possible from the contentious group. If OPEC took 1 mb/d off the market in January, why are prices struggling to move from the low- to mid-$50s?
Of course, rising U.S. production is part of the story. The latest weekly EIA data puts U.S. output at 8.978 mb/d, a touch below 9 mb/d, which is up more than 400,000 bpd from a few months ago. In addition, the EIA's Drilling Productivity Report estimates that production from the major shale basins will rise in March by nearly 80,000 bpd, the largest increase in five months. Nearly all of that increase is expected to come from the Permian Basin. Related: Oil Prices Head Lower In Spite Of Bullish OPEC Data
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But on top of rising U.S. output, OPEC's cuts are less impressive than they might seem. Output from Libya is up more than 100,000 bpd from November and up nearly 0.5 mb/d from its lowest point last year, with more gains to come. Nigeria also threatens to sabotage the OPEC deal if it restores around 0.5 mb/d of disrupted supply.
Moreover, Saudi Arabia ramped up output just ahead of the deal, blunting the impact of its cuts - it cut from a historically high levels. Also, Iran was allowed to increase production slightly, and Iraq, the other major producer in OPEC, is falling short of its pledged cuts. As for non-OPEC countries, Russia has only lowered output by 100,000 bpd compared to its promise of a 300,000 bpd reduction. At any rate, Russia cut from post-Soviet record highs as well.
In short, OPEC has indeed achieved a very high level of compliance, but the underlying math is not all it seems to be. OPEC succeeded in sparking a highly bullish mood in the oil market, but oil traders and investors are starting to catch on to the fact that there are still supply overhang problems in the market. Related: Wind Energy Is Now The Largest Source Of Clean Energy In The U.S.
That creates a downside risk to prices in the very near future. Hedge funds and money managers have amassed the most bullish combined position in years, with everyone going long on oil, betting that $60 was around the corner. With prices now being met with resistance, the danger is that more traders start to bail out of those long bets, sparking a sudden correction in prices on the downside. "There's starting to be fatigue about the range we've been trading in," John Kilduff, a partner at Again Capital LLC, said in a Bloomberg interview. "It won't be summer until we break out to the upside."
Looking forward, everyone will watch how the same dynamics will continue to play out - bulls will watch for steady OPEC compliance and inventory declines while pessimists will keep an eye out for rising U.S. output and questionable demand from China and India. The market continues its slow and painful adjustment process, which should see more price gains at some point in the future, but the short-term looks more shaky.
"There's a lot of complacency out there. If these bets start to unwind, it will be a bloodbath," Doug King, chief investment officer at RCMA Asset Management, told the Wall Street Journal in an interview.
By Nick Cunningham of Oilprice.com
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Nick Cunningham is an independent journalist, covering oil and gas, energy and environmental policy, and international politics. He is based in Portland, Oregon. More
Comments
The Saudis cutting nearly a million barrels per day over a few months is huge. If U.S. imports start to drop accordingly U.S. inventories will drop quickly as the Permian cannot ramp to match. Like trying to convince the bond market fed run off is not a big deal.
Add to this the fact that most non-OPEC producers have low compliance, that many countries have increased production, and that American shale is expanding very rapidly. Some producers timed their cuts with maintenance that would have temporarily cut production anyway. And they have not cut their longer term exploration and drilling.
The media also misinterprets US inventory changes. True, rising inventories are bearish, since they must eventually be sold. But falling inventories (at the current historically high levels) are not bullish. When prices begin to fall, and once oil bought months ago has been delivered, there will be a rush to sell inventory. So inventory will fall as prices fall. It costs money to store oil. Also, outside of the US (both on land and parked tankers) inventory numbers are unverifiable but probably huge, so this is an added downside risk.
"U.S. To Sell 10 Million Barrels From Strategic Reserves This Month" Irina Slav, OilPrice.Com/Energy/Crude-Oil/US-To-Sell-10-Million-Barrels-From-Strategic-Reserves-This-Month.html
Some 10 million barrels of crude from the U.S.’s strategic reserve are scheduled to be sold later this month (Feb 2017), the Department of Energy said. ... EIA reported a massive build in commercial oil stockpiles, at 13.8 million barrels; shale continue ramp up, encouraged by higher prices; investor attention more focused data from US, hence likelihood of the SPR sale affecting prices.
... after API’s report, OPEC officials ... quick to tell media production cut agreement going well & possibility will need extended beyond June deadline ... (Place your bets: Me, buy on rumor sell on facts; leave before the party ends!)
Which Country will take the biggest hit in terms of not being able to support production at lower prices is anyone's guess, but I would suggest two key factors at play: 1) Obviously the lowest price producers have an advantage, still the middle east by far. So those who produce at a higher cost will be first to go, except 2) Political issues impact the actual production price and countries that use oil to support political regimes may not be able to sustain their production as price drops cut into the regime support since profit drops disrupt their ability to sustain basic standards of living for the people. Look for Venezuela and potentially even Russia to become more and more unstable as prices decline. This could finally pull some significant production off the market and change oil dynamics. Until then, ain't not way I would invest in this bear market rally.
Who goes bank
The fact is that the world is awash in oil. Most OPEC countries are cheating, and its only because Saudi Arabia has stepped up and lowered production even further that we don't have a flood of oil over the production guidelines.
Meanwhile the USA is proving that it has succeeded in lowering the production cost and that $50 a barrel oil is now enough to spur production, and they are also proving that the time to market isn't years anymore, but months.
So a glut of oil remains sloshing around the world, OPEC nation are cheating and how long before they cheat even more and Saudi Arabia realizes it can't play that game, and meanwhile USA production is coming on strong.
This article make clear the only hope for sustaining or getting a higher price is that Summer Driving kick in and give the industry another talking point to prop up prices even though there will still be a glut, and a growing glut of oil on the market.
And the article points out that there is always a good possibility that reality will become to great to ignore, and speculators will be forced by Supply and Demand to unwind their positions, and when that happens the artificially high price being held up now will crash back rapidly to where the glut says it should be which is not more than $30 a barrel. Of course, when everyone in such a huge industry are determined to collude to keep prices higher despite the glut of supply they can do it for awhile. We'll see how long?
I'm a new contributor and I really like your coverage of the oil space. It surely must be self-evident that what you are saying is true, viz. the focus should be on supply (clearly de trop) rather than on demand.
Brian Noble
What all the commentators are forgetting is natural field decline. Production currently ex OPEC ex US is declining 3-5% per year, soon without the needed investment it will reach 5-9%
That's anywhere from 1.5mn to.2.5mn barrels per day per year and potentially increasing to 2.5 to 4mn bpd PER year. Then add on additional demand or 1.2 to 1.5 per year and then changes to shipping specs which could increase demand for diesel and light sweet crude by 1mnbpd in 2020 and you are left with a great big hole.
Not everyone can produce at 30 bucks in the Permian many have all in costs at 70 bucks.
It's no wonder people like Shell are pulling out of Canada and cancelling long term investments.
2020 is the cheapest part of the curve right now at 52.50 it's asymmetrical risk to the upside.
The cuts will continue and once out of Siberian winter Russia can also start increasing its cuts.
Saudi wants higher for the IPO as do all members for their extravagant lifestyles and to keep their populations happy.
I expect the cuts to continue for 2years+ until wee see prices at 70 but by then it will be too late to stop the spike from happening.
$90 calls on dec20 are looking pretty interesting