Damned if they do and damned if they don’t. This is OPEC’s precarious position after the recent fall in oil to below $50 per barrel. Oil prices will tank if OPEC says that they are not open to extending their production cuts for another six months. On the other hand, if prices remain low, OPEC only stands to lose market share to its competitors by continuing the production cuts.
So what will they do?
For the whole of last year, OPEC had been supporting prices on speculation of an impending production cut. In January of this year, the production cuts became a reality, and the oil cartel achieved an exemplary compliance rate of above 90 percent for both January and February on its agreed plan.
But prices have not reacted the way many had hoped. After breaking out of the long-term resistance of $52 per barrel, oil was unable to rally above $55 per barrel on a sustained basis. Oil traded in a narrow range for more than two months before breaking down below $50 per barrel on March 09, and is now headed lower.
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But why did prices breakdown instead of skyrocketing higher given OPEC’s production cuts?
OPEC’s bête noire, the U.S. shale oil drillers, have used higher prices to add new rigs for the past eight weeks in a row. In the week to March 10, the total rig count increased to 617, compared to 386 a year ago, according to energy services firm Baker Hughes Inc.
Though the rig count is still way below the peak of 1,609 reached in October 2014, the recovery from the six-year lows of 316 rigs in May 2016, has been outstanding. The drillers have added rigs for 37 of the past 41 weeks, bringing 301 rigs online in total, notes Reuters.
As a result, U.S. crude oil production, which had dropped from the highs of 9,600,000 bpd in June 2015, to a low of 8,428,000 bpd in July, 2016 is on the rise once again. In the week ending March 3, 2017, U.S. crude oil production had risen to 9,088,000 bpd. The worrying part for OPEC is that the EIA estimates that U.S. oil production will average 9,210,000 bpd this year, though many experts believe that the number is likely to be revised higher if oil prices remain north of $50 per barrel.
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So while OPEC has reduced its production, the U.S. oil inventory continues to hit new records every week. Crude stockpiles have risen to 528.4 million barrels, with 8.2 million barrels of stocks being added in the last week alone.
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U.S. shale oil drillers are having a party; meanwhile, Saudi Arabia is leading OPEC’s production cuts. Saudi Arabia desperately wants higher oil prices, which would mean it would get a premium valuation for its flagship Aramco, when it lists. However, there is only so much they can cut in order to fulfill OPEC’s compliance. Related: Libyan Oil May Be Slipping Out Of Putin’s Reach
We had a veiled warning in this regard from the Saudi oil minister Khalid Al-Falih recently when he said : "We’ve been willing to do it [shoulder a disproportionate share of the production cut] for the front end but we expect our friends and partners to pick up the slack as we move forward," reports Bloomberg.
For the U.S. shale oil producers and others wanting to make use of the current higher oil prices to increase production, the minister said: "My optimism should not tip investors into what I would call irrational exuberance or wishful thinking that OPEC or the Kingdom will underwrite the investments of others at our own expense and long-term interests …" A temporary glut is one thing, "intervention in response to structural shifts is largely ineffective," reports the Weekly Standard.
These warnings show Saudi Arabia’s growing frustration. After having cut more than its quota, it is just not getting the support it needs from the production cut members. If the situation doesn’t improve in the next few weeks, it is unlikely that Saudi Arabia will continue to shoulder the responsibility alone. Related: Huge Oil Find Could Save Alaska’s Oil Sector
So, will Saudi Arabia ditch the idea of an extension of production cuts into the second half of the year?
The most likely possibility is that they will not give any clear indication on the extension, until the meeting on May 25, 2017. They will keep all options open.
If oil quickly recovers and sustains above $50 per barrel, the possibility of the cuts getting extended for another six months increase. On the other hand, if oil prices remain below $50 per barrel, even after achieving the targeted cuts, chances are that Saudi Arabia will not opt for an extension.
Meanwhile, OPEC is likely to engage the U.S. shale oil producers in some kind of a discussion in hopes of coming to some understanding, wherein U.S. shale doesn’t increase production at breakneck speeds, allowing prices to remain above $50 a barrel. However, this is easier said than done.
So, for now, there is no clarity on the extension of the deal. OPEC will remain in a wait and watch mode, with oil’s performance between now and May being the key factor.
By Rakesh Upadhyay for Oilprice.com
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