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OPEC Won’t Cut, Markets Remain Oversupplied

OPEC Won’t Cut, Markets Remain Oversupplied

First of all, we take a look at this week's key figures for the oil & gas industry. We see that U.S. oil production is slightly up, whereas oil futures have been trading lower. Gasoline prices continue their trend downwards.

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Today is OPEC day, and as expected, the meeting in Vienna has roiled oil markets. There was little expectation of an agreement on production cuts, despite the majority of OPEC members pleading with Saudi Arabia to reverse course and cut back the cartel’s output target level, which stood at 30 million barrels per day (mb/d) heading into the meeting.

There were rumors that Saudi Arabia floated the idea of agreeing to a production cut of 1 million barrels per day, but only if several major non-OPEC oil producers also agreed to restrict output. The Saudi proposal reportedly included countries like Mexico and Russia, a longshot bid to spread the burden across oil producers worldwide. It would obviously also put restrictions on output from several OPEC members that are in serious financial trouble. The proposal was probably too difficult to ever be taken seriously, but media reports of Saudi flexibility sparked a brief rally in oil prices.

More news ahead of the meeting: an internal OPEC report concluded that even if the group decided to cut its production target, it probably wouldn’t be enough to significantly boost prices, due to the vast levels of oil currently in storage. The OPEC report was not made public, but was obtained by The Wall Street Journal. It illustrates the anxiety within OPEC, and its likely inability to increase prices. Only a massive cut in output levels – something that is off the table for OPEC member countries – could increase prices substantially in the short-term.

Thus, there was little room for agreement on changing course. At the time of this publishing, it appears that OPEC emerged from its meeting with no decision on a change in the production target. Confusingly, media reports surfaced that said OPEC agreed to lifts its output target to 31.5 mb/d, a 1.5 mb/d increase over the current target.

But at the OPEC press conference – delayed no doubt due to the confusion – the OPEC President said that OPEC had not agreed to a production target increase, but instead decided to leave production levels where they are. When pressed by the media, he said OPEC has agreed to current “actual” levels, not the current official target of 30 mb/d. As such, OPEC, while not officially raising the target, has acknowledged that the group is producing in excess of 30 mb/d. Current actual production levels are somewhere around 31.8 mb/d. Related: Global Solar Alliance Sets $1 Trillion Investment Goal For 2030

OPEC did not come to a decision for one main reason. Iran is set to return to the market – around 500,000 to 1 mb/d could come online over the next year or so. OPEC said it would revisit the situation in the next few months to evaluate next steps.

What to make of this? On the one hand, nothing changes in terms of where actual oil production is going. All members of OPEC will continue to produce as much as they can, just as before. The current target of 30 mb/d has not held back members from collectively exceeding the target. The new reality is that OPEC is (sort of) officially recognizing that countries can produce above the 30 mb/d target.

On the other hand, the non-decision does have symbolic value, which was not lost on the oil markets. That is, OPEC acknowledged it is not prepared to cut for the foreseeable future, so the elevated levels of production will continue. The global oil markets remain oversupplied, and OPEC will not be the one to rescue the market, at least not for another six months. Iran will come back to the market, and OPEC is more likely to raise the ceiling in recognition of that fact, rather than cut. OPEC said it would work with non-OPEC producers in 2016 to see if an accommodation could be reached, but that remains unlikely. WTI was down 1.6 percent following the meeting on December 4, and Brent was down 0.5 percent.

One final intriguing note from Vienna: OPEC said that it is possible that they could meet again before its regularly scheduled June 2016 meeting. That does leave open the possibility of a coordinated production cut, but again, there is a lot of uncertainty at this moment in time. Translation: markets will remain oversupplied in the short-term. Related: Crude Tanks As OPEC Refrains From Cutting Production

Separately, Reuters reported that Iran and China are growing their oil relationship. Iran reportedly agreed to sell 505,000 barrels per day in 2016 to Sinopec, China’s largest oil refiner, as well as to Zhuhai Zhenrong Corp., a state-owned oil trader. With a half million barrels per day agreed to, Iran will likely be able to ratchet that amount up further as it finds more buyers. The move also shows that Iran is getting a head start on reclaiming some lost market share, and the battle for market share in Asia – the most sought after region for Middle East oil exporters – is heating up. Put another way, OPEC has lost much of its ability to manipulate oil prices, as its members are increasingly competing against each other for market share, rather than working together. At the same time, OPEC has to deal with increasing competition from Russia. With so much oil floating around, oil markets are decidedly in the favor of buyers over sellers.

China is expected to double its crude oil purchases for its strategic petroleum reserve in 2016, as it takes advantage of the ongoing downturn in prices. China could add another 70 to 90 million barrels of oil to its SPR, Reuters says. The stepped up purchases could help to ease the glut just a bit, shaving off some of the 2 mb/d in excess capacity, although probably not enough to significantly move the needle on global crude prices. The 70 to 90 million barrels of stockpiling would vastly exceed the 30 to 40 million barrels expected to be filled in 2015.

Back in the U.S., the House of Representatives passed a sweeping energy reform package on December 3, a bill that included a repeal on the crude oil export ban. H.R. 8, or the “North American Energy Security and Infrastructure Act of 2015,” would also accelerate LNG export permits and address the aging U.S. electricity infrastructure. President Obama promised to veto the package because of the language that would diminish the administration’s ability to evaluate LNG export permits. Obama has also previously opposed lifting the ban on oil exports. The bill is expected to go nowhere.

But on the Senate side the top Republican on energy issues, Sen. Lisa Murkowski (AK), said that the Senate would push an energy package in the New Year, which she says will meld a bill passed by committee this past summer with the recently passed House version. The Senate is trying not to bog down the bill with provisions that will prevent its passage, and Murkowski thinks they can send a bill to the President’s desk next year.

While the fate of the legislation is unknown, Democrats and Republicans could negotiate a compromise that would see the removal of the oil export ban in exchange for an extension of subsidies for renewable energy. There is currently a lot of jockeying behind the scenes over a potential deal, and while agreement is far from a certainty, the two sides are closer than they have been in a long time.

By Evan Kelly of Oilprice.com

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