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Oil prices got a modest lift last week on word OPEC may be upping the production cut ante, but gains were balanced by signs of Russian production growth.

 

A research from PVM (International oil brokers & consultants) suggests delegates at a May meeting of members of the Organization of Petroleum Exporting Countries may consider deeper cuts than already implemented under a six-month deal that began in January.

 

Libya and Nigeria are exempt from the deal and Iran has room for production growth as it seeks to regain a market share lost to sanctions. Saudi Arabia, the largest producer and de facto head of OPEC, has cut its output more than any other and total group production is already below the 32.5 million barrels per day target.

 

PVM finds the May meeting could lead to an extension of the deal for another six months, though market reactions were muted as the November provision mandating the cuts already included a clause on a six-month extension.

 

Elsewhere, PVM reports that Russian crude oil exports could increase by more than 5 percent this year even as it clings to its commitments to OPEC’s managed decline agreement as a non-member participant. For other non-members, Norway, which is not party to the agreement, said job openings were on the rise in its oil and gas sector.

 

Nevertheless, there are no catalysts that could drive oil significantly up in the near future. Talk of extending production cut deal is a confirmation of failure, not success. Any oil break will be to the downside over the next couple of months.

 

It’s increasingly obvious that OPEC’s position of influence rapidly waning

 

The days of OPEC manipulating the range of oil prices are over. Oil stockpiles continue to climb even as the cartel touts record compliance to the output cut deal. With the price of oil in a holding position, there is no place for the price of oil to go but down if the price breaks.

 

OPEC and Russia have no other tools left to support the price of oil; this deal has failed to accomplish what it set out to do, and will continue to struggle to hide it for the duration of the deal.

 

This is why the cartel is floating the idea of cutting deeper and longer. The lacks of catalysts at the fundamental level of the oil market make this the only arrow it has left to shoot.

 

The problem are the cuts; there is so much supply coming to market, it is offsetting the cuts put in place, reinforcing the reality the oil market of today has completely changed from what it was even two short years ago. What worked in the past to support oil no longer does.

 

Doubling down and cutting deeper and longer will only make this more obvious. This only confirms the fact the cut isn’t working and supply from outside of OPEC and Russia is far more robust than being portrayed.

 

Is compliance really at over 90%?

 

OPEC may still be able to control oil prices to a limited degree, but the benefits of that control will accrue to parties outside the cartel.

 

There are three things for investors to seriously consider with oil and this production cut deal.

 

Either supply estimates continue to be underestimated, the percentage of compliance is bogus, and consequently there is a lot more oil coming from participants in the cuts than is being acknowledged. It can’t be both ways. Either the cartel has once again underestimated the amount of supply available in the world, or is totally incompetent in its outlook, or is lying.

 

I understand the deal is still young, but we’re approaching the latter part of the second month. As the warmer weather approaches, it’s more likely an increasing number of participants from the Middle East, and also Russia, will be tempted to cheat on their quotas.

 

My view is this had a better chance of being considered legitimate if it worked in the early stages of the agreement. It isn’t even close to happening as oil stockpiles climb. If compliance numbers are truthful, it means production is far stronger than is understood or admitted.

 

As for compliance itself, it’s irrelevant if the supply continues to add to, or sustain stockpiles, at high levels. The purpose of the deal in the first place was to decrease inventories while demand caught up with supply. If that doesn’t happen, which is highly unlikely, the deal itself is meaningless, let alone compliance levels.

 

If oil breaks, it’s going to be to the downside

 

With nothing left in the short term to be an upward catalyst for the price of oil, the only direction it will take, if it breaks, is down. The only caveat is if something outside of the fundamentals happens, such as an interruption in supply from militants or another source, such as sanctions on Iran.

 

If there is a deal to cut deeper for longer, all it’ll do is confirm that the former methods to support oil no longer work, for the reason the market is completely disrupted and different than it was in the past.

 

This is obviously due to the emergence of the U.S. shale industry, but it also includes significant increases in supply from Canada and Brazil this year, which is projected to surpass 400,000 more barrels per day in 2017.

 

A downward move in price isn’t a surety. I’m only saying if there is a big move in oil, it’s going to be in that direction, not up.

 

Some are interpreting the battle now being waged as OPEC versus U.S. shale, but in reality it’s closer to those not participating in the production cut, against those agreeing to output quotas.

 

That’s important for investors to understand because it implies whatever happens with U.S. shale is what will determine the price of oil. Closer to the truth is what happens with other major producers like Canada and Brazil, along with U.S. producers, is what will determine the level of impact OPEC and Russia will have on the market.

 

U.S. shale is important as we have no idea what level of supply the industry will add to the market in 2017. We know it’ll be much more than being produced today, but with the increase in productivity, how much more oil will be added to the market from completed wells and an increase in rigs, is only a guess.

 

I believe it will be much higher than projected, probably being closer to 500,000 more barrels per day coming from that market segment this year. Another factor is much of the resilience of the U.S. oil industry so far in 2017 has come from offshore and Alaskan oil, not the shale sector.

 

Based upon the fundamentals and the disappointing results from the production cut deal, oil will either remain in the $50 to $55 per barrel range, or it’ll take a hit to the downside as longs get nervous from the failure for inventories to be cut and demand to catch up with supply at the pace they’ve been looking for.

 

Most important in all of this is the understanding the former powers in the industry – OPEC and Russia, are fading in influence, and investors can no longer count on old methods of artificially propping up the price of oil to continue to work.

 

By Vasko Nachev

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