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The Math Doesn’t Add Up For The OPEC Deal To Work

Ghawar Oil field

The basic laws of supply and demand can easily cause the OPEC production cuts to not work, but there are other factors to also consider. These factors include U.S. shale production, political stability returning to Libya and Nigeria, the amount of oil sitting in storage and rising role of renewable energy.

U.S. shale producers were a leading factor in the 2014 oil crash because of how much oil they brought to domestic and international markets. Since then they have shed billions in unproductive assets and have lowered break-even costs, which means they can quickly start to replace supply that OPEC is attempting to cut. OPEC could be taking a huge risk betting against shale producers.

No one is as technologically experienced or has such large shale finds ready to be exploited like the U.S. OPEC will need 100% member compliance to ensure shale doesn’t keep oil prices lower than is currently being assumed.

There are approximately 30 oil-producing U.S states, and with a more energy-friendly incoming administration, pipelines such as the Keystone XL and Dakota Access are likely to be approved, leading to increased heavy oil flows from Canada and the Bakken. Has this potentially significant new amount of oil been factored into the production cuts causing prices to rise? It doesn’t seem it has.

Libya is ramping up oil exports after political reconciliations facilitated by the United Nations, and they are exempt from OPEC cuts. In the near-term, Libya could put 700,000 to 900,000 barrels per day on to the market. However, the Libyan government believes they can ramp up production to 1.1 million bpd by the end of 2017, which is a significant amount unaccounted for during this current trading uptick.

There are still challenges in Libya between the Petroleum Facilities Guard and the Libyan National Army, but even if these tensions endure, significant amounts of oil will be shipped to an already oversupplied European market. Related: The Next Big Innovation In Oil & Gas: Cloud Computing

Another complicating factor is Nigeria which has been trying to reach some kind of settlement with militants which have been bombing its oil facilities while trying to woo oil majors to raise investment and production. All of their internal problems aside, the African nation still produces around 1.6 million bpd with near-term goal according to President Buhari to reach 2.2 million bpd.

Another indicator that could put a damper on rising oil prices is the amount of crude currently sitting in storage. The U.S. has roughly 500 million barrels in storage, OECD nations have another 375 million barrels, and China has over 400 million barrels in storage while attempting to expand its reserves to 500 million barrels. At some point investors and the market have to account for this inventory.

The storage issue is further complicated by Supertankers used for storage. These massive vessels that are now parked from Singapore to Europe are under no obligation to report accurate supplies as well. They can be tracked by satellite and reporting done at docks and ports, but this makes for cryptic and volatile markets. For an investor or interested parties in the OPEC production cuts it should be understood how fast can this crude be sold on the market and how much it could affect prices. Related: U.S. Oil And Gas Jobs See First Gains In 2 Years

Cheating on the production cut quotes by the likes of Iran, Iraq and potentially Saudi Arabia are other influences not being put into consideration by anyone who has a vested interest in oil reaching the $60-70 dollar per barrel range. If OPEC members fail to live up to production quotas, prices might fall much faster than anticipated as supply will continue to outpace demand.

With the Chinese economy now emphasizing stability over growth, and uncertainty about the growth prospects of the European economy, these large economies are reducing demand growth and this doesn’t bode well for oil prices rising in 2017.

Abovementioned are some of the issues that can cause oil to plateau before even reaching $60 a barrel. Every energy investor and interested party in fossil fuel’s stability wants to see job growth and geopolitical steadiness. Particularly, countries that depend heavily upon higher oil prices to fund their government budgets. Failing to understand the factors that can stall this rally could bring back a 2014 scenario that saw investors, companies and governments lose hundreds of billions of dollars.

By Todd Royal for Oilprice.com

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  • Bud on January 12 2017 said:
    Aramco and the other GCC producers started this rout by adding a few Mbpd when the global market was already oversupplied between July 14 and July 15. Whether or not Nigeria and Libya can get a sustained combined production increase of 500kbpd is no match for a GCC that has increased production 3 Mbpd since 2014 if they are, with Russia, serious about a higher price. Nigeria, Libya, Iran, southern Iraq are all complicated and present real challenges for service providers and partners to commit to spending money needed to increase production long term.

    U.S. Inventories are up due to heavy imports from OPEC and new fields in the GOM primarily. If trump slows imports or makes them more expensive, this will have a greater impact then a 500kbpd increase from the domestic frackers. The growth curve for the frackers was permanently kinked by OPEC and the larger players will grow while the spigot for most small and medium firms is likely off for a good while, especially given the new bank and leverage rules.

    The GCC clearly targeted reserves as they changed signaling the month sec pv10 stopped dropping, which also showed the Saudis were not going to risk sending prices back into the 30s which would have guaranteed foreign reserves would breach 500 billion by 2017.

    If you have a detailed global field by field model with perfect data, which few if any have, let us know, but traditional volatility would indicate a 95 percent confidence range from low 30s to low 70s for 2017. Given the Saudis can buy futures like anybody else and we are right in the middle, I would say the bias is on the up unless the new admin wants to suppress prices like the outgoing.
  • Amvet on January 12 2017 said:
    Supply and demand controlling the market? Where have you been? The market is controlled by massive futures trades.
  • Russ Ramey on January 12 2017 said:
    Correct me if I missed something since 2008-2016.
    ? "unless the new admin wants to suppress prices like the outgoing." ?
    Were there policies that suppressed energy prices?
    The willful depression of supply side and infrastructure like pipelines, absolutely.
    My constant impression was the push for alternative energy becoming more viable, hence driving prices up. Solar, wind turbines, electric vehicles, etc.
    Weren't the coal, nuclear, natural gas, shale industries actively retarded during the Obama Administration.
  • Matthew Biddick on January 12 2017 said:
    The 500 miilion barrel figure quoted in the piece is the total barrels it takes to "prime" the entire system of production, transportation, and refining, and yes, the storage of some surplus oil (as at Cushing, OK -about 66 million barrelsNo). It is not 500 million barrels of oil that no one seems to want to use. I can't be sure, but I'll bet the foreign figures quoted are similar in nature.

    I can't see US production growing by even 500,000 bopd in 2017, even though there has been a fair amount of increase in the rig count. The US companies that have survived are not run by dummies. They know if they ramp up production that they'll be slitting their own throats. From what I've read, they hope to maintain their current production (replace natural decline) and reap the benefits from hopefully higher prices, which if they are truly not dummies, they will use to reduce debt.

    While no one is seemingly paying attention, India's consumption is growing at 11%/year. World consumption is growing at 1.3-1.5 million barrels per day year after year after year. Oil price may not "spike" this year but the upward pressure on price is here to stay I think.
  • jman57 on January 12 2017 said:
    Also what doesn't add up is that OPEC's cut deal was based on obsolete October numbers. Their production has increased significantly since then and demand is much less this time of year than October. Oil price is being held up (for now) based on hope alone, yet inventory numbers are already showing that the deal was nothing but hot air.
  • Brent Chitwood on January 12 2017 said:
    Maybe it can't be done, but can't we project U.S. production by modeling the age and output levels (and projected declines) of the wells? It seems to me that there are thousands of early drilled fracked wells that are quickly coming to their rapid decline point of their life cycle. It took 850 well drillers over time to get production to where it is. Even with the new higher quality wells that we are tapping now, we must be getting closer to a more rapid decline of the old wells.
  • Dan on January 13 2017 said:
    I believe looking at all oil in storage as supply is incorrect. Some countries see this period of insane low price of a needed commodity relative to their debt, global debt at 325 percent of GDP, a means of moving oil from the drilling costs to cheaper above ground storage. Each being a place of storage but with different costs. Oil should be at $150 looking at debt of currencies or above so even if one barrel is sold it should be $150 plus. Think of it as living in a global hyperinflation Matrix.
  • petergrt on January 14 2017 said:
    Great article, including some of the comments.

    I do believe that a 2014 style crash will be revisited - probably in 2nd half of 2017, when the countries that greatly depend on oil revenue will come to realization that while the prices haven't moved up much, they would have lost a significant market share.

    These countries have no alternatives but to produce and sell more crude. The Saudis have come to the realization that the time is fast running out and have started a plan of diversification, but that needs time and a lot of $$, so they cannot cede their market share because they may not get it back . . . .ever.

    Incidentally, the US has produced nearly 200k bpd more just in the last week, and Canadians are also going gangbusters, and interestingly, the Russians are greatly expanding their shale operations as well, as are Argentinians (but the latter may never happen as Argentina is likely to revert to Socialist poooopsters soon) . . . .

    And yes, I have shorted oil and will add if the price gets over $55.
  • TC on January 15 2017 said:
    One thing people are forgetting to mention, including this article, is China's shale revolution. China could potentially have more reserves than the US. Their costs to buy imports are rising and they are throwing money at the yuan to artificially support it. When that currency starts to falter, and will probably tank soon, that just adds to the cost per barrel to buy from outside the country.

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