To the surprise of many, the OPEC and NOPEC deal is not only holding but overperforming. The compliance rate stands at 91 percent, with the recent OPEC Oil Market Report declaring a total cut of 890,000 bpd. Saudi Arabia has been cutting more than it initially promised. Russia has reduced some 100,000bpd in the month of January. This would seem to paint a promising picture for the future of oil markets, only a month and a half into the production cut agreement and the prices have been moving to and fro in the $50-$60 band. There is a catch however, of-late the market is basically focusing on two things, short-term movements and supply. But it is ignoring the most significant factor responsible for driving oil prices upward - demand.
The IEA released its Oil Market Report on February 10, 2017. It was certainly bullish but with a flash of caution. The report showed that “OPEC crude production fell by 1 mb/d to 32.06 mb/d in January, leading to a record initial compliance of 90 percent with the output agreement. Some producers, including Saudi Arabia, cut supply by more than required. Lower production was partly offset by higher flows from Libya and Nigeria, which are exempt from cuts.” Moreover, the Paris based agency has predicted that NOPEC output will grow by 0.4 percent in the current year (2017). This is due to three main factors. First, and most importantly, U.S. Shale. Due to the rise in oil prices the U.S. nodding donkeys are busy pumping black gold from the ground. The rig count has increased year over year, now standing at 591 rigs as per the latest Baker and Hughes rig count report. Second, countries like Libya and Nigeria continue to increase output. Third, oil exploration and production deals are returning to the market as investors pour money back into the sector. The IEA predicts a growth of 175,000bpd in U.S. production this year. Related: Why Sub $50 Oil Is More Likely Than $70 Oil
The IEA has increased its outlook for demand to 1.4mbpd – a near-insignificant increase of 0.1 percent from its last report.
Mr. Leonid Bershidsky, a BloombergView Columnist, very rightly observes that “The developed world's commercial oil stocks dropped in January, but they still stand at around 299 million barrels above the five-year average. If the stocks fell by the entire amount of the January production cut, it would take them 200 days or more, depending on whether the IEA or OPEC got the size of the cut right, to get them to that average level. Of course, the stocks won't fall this quickly because the market is not balanced yet”.
It may be that we are focusing on the wrong side of the equation. The effect of these short-term speculations and production cuts will be offset by lower demand and the increase in U.S. shale production. The story remains the same. This is a dilemma, a vicious circle to which there is no end. In another article No Refuge for Oil the writer explains the above situation as: What, then, is the panacea? I am afraid there is none. The markets have to wait. Patience is the key here. If the OPEC and NOPEC producers remain true to the Vienna Deal - which is only for the first six months of the current year - it may still take a year for the oil glut to drain. But a very relevant condition for this drainage to eventuate is demand, and it looks to be waning. China’s economic growth is not looking very promising. This price cap may, in the future, effect the compliance of oil producers if they do not see any positive impact from the deal.
It certainly is a test of patience. Patience for demand to once again step in.
By Osama Rizvi for Oilprice.com
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