OPEC’s decision to hold a previously unscheduled meeting next month in Algeria sparked a massive price rally, adding about $8 per barrel to WTI and Brent in short order. But Goldman Sachs says that even if OPEC does agree to something in Algeria, such as a production freeze, the move would be “self-defeating.”
It should be noted that most oil market watchers see the prospect of a deal in Algeria as slim. Iran has previously insisted that it will not agree to a production “freeze” because it has not yet reached its pre-sanctions production levels. But, the chances of a deal are much better than they were in April, when OPEC and Russia previously attempted to reach an agreement on a freeze. After all, Iran is closer to the production levels it saw before international sanctions and all parties involved probably do not want a repeat of the mess in Doha.
But the aim of the freeze is unclear. Saudi Arabia has ramped up oil production to even higher levels compared to April, reaching a record high 10.67 million barrels per day in July. The UAE has also increased production since April, and Russia too is producing at or near post-Soviet highs. Iraq just announced that it would bring another 150,000 barrels per day of oil exports back to the market after it restarts oil flows from fields in Kirkuk. With so many of the participants in the Algeria meeting pushing output to high levels, the freeze will mean very little.
Even if the intention is to spark a rally merely by meeting and agreeing to a hollow accord – the prospect of which has already sent oil prices surging off of recent lows – the effects could be fleeting, and in any event, “self-defeating,” according to a Tuesday report from Goldman Sachs. If the freeze sent prices shooting up beyond $50 per barrel, that would simply make room for more shale production, throwing struggling producers a lifeline. To the extent that OPEC members limit their production, they will allow drillers in Texas to fill that void. “A production freeze would also likely prove self-defeating if it succeeded in supporting oil prices further, with the U.S. oil rig count up 28 percent since May,” Goldman Sachs wrote.
Goldman was unimpressed by the latest oil price rally, reiterating its call for oil to trade between $45 and $50 through the summer of 2017, essentially unchanged from today’s levels. Related: The Permian Pitfall: A Race To The Bottom For Tight Oil
That would back up a theory put forward by Olivier Jakob, managing director of Petromatrix, who said in 2015 that the advent of shale production has changed the game for pricing. In 2015 Jakob said that while oil prices will remain volatile, they will trade within a narrow band of $45 and $65 per barrel. If prices test the lower end of that band, shale production quickly drops off as companies scrap rigs and cancel drilling plans. When prices subsequently rise, bumping up against the upper end of the shale band, E&Ps spring back to life and drill all over again. The resulting surge in supply prevents prices from rising above the $65 band. In the end, prices would bounce around within that shale band.
Jakob’s theory has held up pretty well, although he lowered his projected price band to $40 to $60 per barrel as shale producers proved to be resilient. In the summer of 2015 prices rose above $60 per barrel but only briefly, falling back again by August. Prices then dipped to lows in February of this year, dropping below $30 before bouncing back. Then, WTI and Brent hit $50 in June and fell again back towards $40. Now, prices are once again testing $50, but the rally has lost momentum as disrupted supplies from Nigeria and Iraq threaten to come back online.
All in all, the shale band theory appears alive and well. For more than a year WTI and Brent have largely stuck to the $40 to $60 range, only briefly moving beyond those limits. Looking forward, many analysts do not see oil prices moving above that upper band for quite a while – Goldman Sachs is projecting $45 to $50 per barrel a year from now.
By Nick Cunningham of Oilprice.com
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