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Oil Prices Gain 2% on Tightening Supply

Tsvetana Paraskova

Tsvetana Paraskova

Tsvetana is a writer for Oilprice.com with over a decade of experience writing for news outlets such as iNVEZZ and SeeNews. 

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Is A Second OPEC Cut On The Cards?

OPEC

OPEC’s coordinated effort to curtail global supply has so far managed to put a floor under oil prices, which have been sitting modestly above US$50 since the deal was announced at the end of November last year. But resurging U.S. shale has been capping the upside, and Brent has not breached US$58 per barrel. Analysts and experts are now mostly predicting that oil prices will remain below US$60 this year.

The supply-cut deal has so far resulted in a surprisingly high OPEC compliance of more than 90 percent, thanks to the cartel’s leader and biggest producer, Saudi Arabia, which has been cutting deeper than pledged. But the market has already priced in this high compliance, and although oil prices jump for a few hours on every report of ‘extraordinary efforts’ and reassurance that members will strive for ‘full conformity’, they are stuck in a narrow band, kept in check by U.S. shale and record high inventories in America.

A key upside driver for prices would be an extension of the OPEC deal beyond its original expiry date at the end of June. Just over a month had passed since the beginning of the production cut deal when talk of extending the agreement started to intensify. OPEC is said to be prepared to extend the deal, and may also increase the cuts, if inventories fail to drop to a specified level, sources from the group told Reuters. Related: Oil Prices Rise On OPEC Compliance Data And Plunging Dollar

The cartel has always claimed that the primary goal of the cut was to draw down excessive supply and bring the market back into balance. According to its latest Monthly Oil Market Report published in February, total OECD commercial oil stocks fell in December 2016 (before the cuts took effect) to stand at 2.999 billion barrels. At this level, OECD commercial oil stocks were 299 million barrels above the five-year average, OPEC said.

The February Oil Market report by the International Energy Agency (IEA) said that OECD total oil stocks had already dropped nearly 800,000 bpd in the fourth quarter of 2016, the largest fall in three years. Inventories at end-December were below 3 billion barrels for the first time since December 2015. Global oil supplies plunged nearly 1.5 million bpd in January 2017, with both OPEC and non-OPEC countries producing less, the IEA noted. The agency also pointed out that the Brent contango narrowed in the first month of this year.

The contango has been steadily shrinking, and the futures curve suggests that the market is tightening, which could help to draw down excessive storage that has been kept for sale at a later date.

Although OPEC’s secondary goal may be to change the market structure to backwardation, the IEA said in its February report that stocks were still 286 million barrels above their five-year average and “by the end of 1H17 will remain significantly above average levels”. Related: Oil Prices Find Support As OPEC Compliance Nears 100%

So the end of the first half of 2017 may not be time enough to cause the oversupply to dwindle, and OPEC may decide at its meeting in May to further tighten the market by extending the period of the supply cut. The cartel and non-OPEC Russia have said that a possible extension is still too early to assess—a fact that will not keep them from talking up oil prices with hints and comments in the coming weeks and months.

On the flipside, a possible extension of the deal – assuming compliance is high and cheating is low – would give more confidence to the U.S. drillers to increase output at higher oil prices.

At the end of the day, OPEC may have to choose between giving rival higher-cost producers a reason to pump more, or cutting back its supply (and some market share) for the sake of higher prices and market balance. And of course, giving its own member states all the more reasons to cheat.

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By Tsvetana Paraskova for Oilprice.com

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Leave a comment
  • petergrt on March 05 2017 said:
    The Saudis are already having to defend their market share in the far east, where they just lowered their price and where the Saudi king is shopping for more business . . . . .

    But while all the focus is centered around the American shale, more and more production is coming from all over the NOPEC Globe, which is very likely to trigger Russian response as well . . . . . .and incidentally, don't think for a moment that other major producers will be ignoring the Saudis' dramatic increase in exporting of distillates, more than offsetting their reduction of exporting of the crude . . . . .

    The bottom line is that at $50 all producers are making money and most are making well over 100% profit, so OPEC has lost and if they were to reduce the production further, they will loose more still.
  • Bud on March 05 2017 said:
    The U.S. Will drop 300 million barrels alone in 2017 and it doesn't matter what the Permian does since the Permian cannot ramp faster than the Saudis and OPEC can reduce exports to the U.S. Starting in April the Saudis will need to ramp up to an extra million barrels per day for domestic air cooling which means less exports.
  • UncleFred on March 08 2017 said:
    Bud: In an absolute sense you're correct. The Saudi's can just open the spigot, at least at current production levels, so no new drilling can ramp that quickly. However, drilled wells don't disappear when the price goes down, and a domestic well can be uncapped as quickly as the Saudi's can vary their production.

    The average time from when a fracker starts to drill to delivering crude to the market is under eight weeks. As of today there are more that 500 drilling rigs in operation, with nearly that many sidelined waiting for survey completion and crews. In the last few months both Exxon and Chevron have purchased more than 120,000 acres each for additional exploration and development. The surveying crews are working 90+ hour weeks. Each week additional production capacity comes on line, diminishing OPECs ability to dictate oil prices.

    The goal of any price war is to push your competition out of the market so that you can regain control. The Saudis tried to put the frackers out of business with their price cuts. While they thinned out marginal operators, the wells they left behind didn't disappear, they were acquired by healthier operators, and are either online or capped waiting on a price point. Those operators are better situated to deal with another price war, and the Saudis are less well positioned to start one. The Saudis can do what they like, but driving the price up brings additional competition online and every price drop hits them deep in their wallets costing them dollars they'll never see again.
  • Johnny on March 11 2017 said:
    Incoming weeks will be perfect for speculations.

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