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Erasing The Glut: Is 1.8 Million Bpd Enough?

Port Arthur oil storage

Oil jumped by more than 4 percent on Monday, with WTI moving up to $53 per barrel and Brent topping $56 per barrel. It is very possible that we could see oil prices break the $60-per-barrel threshold in short order, and some people are even wondering if $70 oil is not too far off.

The oil market received its second jolt from OPEC discussions in as many weeks, with non-OPEC producers agreeing over the weekend to cut 558,000 barrels per day beginning in January, a bit shy of the original proposal, but an agreement that is nonetheless bullish for the market. It was the first major OPEC/non-OPEC coordination in a decade and a half, and the additional cuts from non-OPEC will come on top of the 1.2 million-barrel-per-day (mb/d) reduction promised in Vienna on November 30. Together, the pledges will go a long way to rapidly tightening the oil market, which is why oil prices are up more than 20 percent in two weeks.

“This is an unprecedented event,” Thomas Finlon, director of Energy Analytics Group, told Bloomberg in an interview. “The 558,000 barrel decline from non-OPEC together with the OPEC agreement will total 1.8 million barrels a day of cuts, which is about 2 percent of global production. This is enough to have an impact.”

Heading into this weekend’s meeting, there were a lot of reasons to doubt that something meaningful would come of it. However, the deal came together because of some surprisingly assertive pledges from Mexico (a cut of 100,000 bpd), Azerbaijan (35,000 bpd), Oman (40,000 bpd) and Kazakhstan (20,000 bpd). It should be noted that Mexico’s reductions, for example, are cuts by attrition – Mexico won’t actually cut production; its oil fields are in long-term decline, so the expected drop off in output in 2017 is simply being counted as a “cut.” Related: Are Airlines The Real Losers Of The OPEC Deal?

Moreover, the potential for cheating has raised questions about the integrity of the deal announced in Vienna a few weeks ago. Oil analysts differ on whether or not OPEC will honor its commitments. Given the long track record of cheating on production quotas, there are good reasons to remain skeptical. Russia’s reputation for cooperation is no better.

But Saudi Arabia’s energy minister Khalid al-Falih sounded more determined than ever to erase the global supply surplus. After the meeting with non-OPEC producers this past weekend, he delivered an unanticipated statement.

"I can tell you with absolute certainty that effective Jan. 1 we’re going to cut and cut substantially to be below the level that we have committed to on Nov. 30," al-Falih told reporters, suggesting that Riyadh would be willing to cut well below the 10.06 mb/d level that it promised in Vienna. Helima Croft, chief commodities strategist at RBC Capital Markets LLC, likened it to a seminal moment on the part of European Central Bank President Mario Draghi, who assured the worried global financial markets in 2012 that he would do “whatever it takes to preserve the euro.” In other words, Saudi Arabia would act as the central banker of the oil world, cutting output when it sees fit in order to balance the market. If he is serious – and he appeared to be – al-Falih suggested that Saudi Arabia would take on additional cuts to be certain that the supply surplus ended. Related: A Real Opportunity For An Oil Price Recovery

Skepticism can still be heard in many corners of the oil world. "As things stand today, no cuts have been made and production is in fact still rising...from a fundamental point of view, it is difficult to justify the front-end price surge other than that is where the liquidity is and where speculative players, moving in herds, always prefer to place their bets,” PVM Oil Associates strategist David Hufton said, according to Reuters.

Nevertheless, the promised cuts of nearly 1.8 mb/d are enormous. Global supplies only exceed demand by a few hundred thousand barrels per day, so even partial compliance with the OPEC deal would mean that the oil market would quickly flip from a glut into a deficit in early 2017. Goldman Sachs offered a scenario in which actual cuts come in at about 1.0 mb/d instead of the 1.6-1.8 mb/d. In that scenario, the bank estimates WTI will average $55 per barrel in the first half of 2017. In a more bullish scenario in which OPEC and non-OPEC fully comply with the promised cuts, an additional $6 per barrel could be added to the oil price, taking WTI over $60 per barrel in the first half of next year.

Of course, higher prices could spark a resurgence in U.S. shale production. The rig count is already up about 50 percent over the past six months. But al-Falih said that shale wouldn’t have an impact right away. "[T]here is a significant time lag with U.S. shale,” he said. A strong response from U.S. shale could take up to a year, which, at that point, the oil market would be in much better shape.

$60 oil is not far off.

By Nick Cunningham of Oilprice.com

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  • John Scior on December 14 2016 said:
    Another factor to consider here is the interest rate movement by the Federal Reserve. The uptick in interest rates will have a cooling effect on not only the US economy but the global economy as well. Other countries will be under pressure to correspondingly raise their rates or risk capital outflow. Thus when other countries raise their rates , the world economy will see a cooling effect as well and put downward pressure on prices. So while on the supply side even under the assumption that the cuts go into place and say independent shale producers don't immediately raise their production, the demand side will see downward pressure which will tend to also apply downward pressure on prices. ( Perhaps offsetting the shift in the supply curve )

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