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Tsvetana Paraskova

Tsvetana Paraskova

Tsvetana is a writer for the U.S.-based Divergente LLC consulting firm with over a decade of experience writing for news outlets such as iNVEZZ and…

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Is OPEC Underestimating U.S. Shale?

The oil production cuts and healthy oil demand growth have helped the global inventory surplus to nearly vanish and it certainly looks very much like OPEC and allies have a “mission accomplished” within reach.

That’s the verdict of the International Energy Agency (IEA), which said last week that OECD crude oil stocks at end-February were just 30 million barrels above the five-year average—with product stocks actually below it—compared to a glut of more than 300 million barrels at the start of the production cut agreement that OPEC and Russia-led non-OPEC partners have been implementing since January 2017.

Today, a leaked OPEC/NOPEC report suggested that the lingering overhang was even smaller—at 12 million barrels above the five-year average.

Still, there are no signs that OPEC and friends would be rushing to declare ‘mission accomplished’. Even the usual OPEC/Russia chatter of ‘gradual exit’ from the cuts once they expire at end-2018 has not been heard on the market for a couple of months. Instead, we’re hearing more reports that OPEC’s de facto leader Saudi Arabia would rather overtighten the market, shooting for oil prices higher than the current around $73 a barrel Brent, which is already a more than a three-year high.

An OPEC/non-OPEC ministerial monitoring panel is meeting in Jeddah, Saudi Arabia, on April 20 to discuss the state of the oil market and possible long-lasting cooperation. According to analysts, OPEC (Saudi Arabia) and Russia look determined to continue with the cuts at least until their official expiry date at the end of 2018, despite the fact that their official target—bring OECD oil stocks down to their five-year average—could be achieved any moment now.

According to a Bloomberg source, 12 nations part of the OPEC+ pact will be meeting in Jeddah on Friday—the energy ministers of Saudi Arabia, Russia, the UAE, Algeria, Kuwait, Venezuela, Iraq, Oman, and Brunei, plus representatives from Azerbaijan and Kazakhstan, and the head of Libya’s state oil firm. Any proposals or recommendations that this group would agree upon need to be later ratified by the full-line-up meeting in June. Related: Canada’s Oil Patch To Turn Profitable In 2018

But it looks like this week the partners won’t be hailing the mission as accomplished and may even discuss moving the goal posts—changing the current ‘five-year average’ metric they use to measure the success of the production cut pact—to justify that the cuts would be in place until the end of 2018.

“All of the various suggestions that have been floated would give OPEC a rationale to continue cutting,” Mike Wittner, head of oil market research at Societe Generale, told Bloomberg.

Although the official goal is to bring inventories back to normal levels, unofficially, the target is to prop up oil prices. Even at above-$70 oil now, Saudi Arabia is reportedly aiming much higher and would even let oil prices rise to as much as $100 a barrel.

The higher oil prices would help the cartel and allies to patch up their budgets that have been suffering from the low oil prices for three years now. Saudi Arabia ran budget deficits that were unthinkable before 2014, and its breakeven budget price is said to be upwards of $80 oil. Then, there’s the much-hyped Aramco IPO, ahead of which Riyadh is also looking for higher oil prices to boost the valuation of its giant oil firm.

Despite the fact that oil at $80 or $100 could backfire on both global supply and demand, with U.S. shale soaring further and demand growth possibly slowing down, analysts see the shortest-term higher budget revenues as the rationale for Saudi Arabia and the cartel to want oil prices so high. In short, they would prefer to rake in the windfall now and think of the state of the oil market later.

“They are willingly over-tightening this market,” Jan Stuart, an oil economist at New York-based consultant Cornerstone Macro, told Bloomberg. “It’s not self-defeating if what you are looking for is a little extra money. If the idea is to get a ton of money in the door now, then they’re probably doing the right thing,” Stuart said.

So analysts don’t expect the participants in the pact to declare ‘mission accomplished’ so early into the year, when an overtightened market and growing geopolitical risk premium could push oil prices even higher by the end of the first half of 2018, or the end of the driving season.

“Would they declare victory now and stop? No way,” Societe Generale’s Wittner told Bloomberg. “They’re happy to see inventories continue to go down, to see prices of $70 or $80. In the end, it’s about revenues. The question is at what point do they become uncomfortable with higher prices?” Related: $100 Oil Is Back On The Table

OPEC’s key partner in the deal, Russia, is generally more cautious about unofficially aiming for such high oil prices, but its Energy Minister Alexander Novak has said that some kind of cooperation with OPEC could be made “indefinite”.

Analysts see Russia’s continued participation in the deal more politically than business motivated. Russia maintains close ties with Iran and is also in a bromance oil-market partnership with OPEC’s largest producer and Iran’s regional archrival Saudi Arabia.

“Politics plays its role of course,” Andrey Polischuk, energy analyst at Raiffeisen Centrobank in Moscow, told Bloomberg. “Russia needs to maintain good relations with its Mideast allies, and now even more than last year.”

It looks like OPEC and Russia are deliberately overtightening the oil market and won’t call the end of the cuts yet, aiming at higher oil prices and shrugging off (at least in the short term) the potential threats to the oil market balance—a shale surge and possible slower demand growth.

By Tsvetana Paraskova for Oilprice.com

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  • Kr55 on April 19 2018 said:
    As Novak says every time he's asked, it's insulting to suggest Russia and OPEC don't understand shale. THey probably understand it better than most shale producers. This is why their focus will start to shift to balancing grades since shale only supplies light end of the spectrum. Shale will be needed, there is an explosion of demand happening in asia and even africa now. the light oil will be needed for gasoline. Medium and Heavy will be in short supply unless OPEC shifts to satisfying that demand that shale can do nothing to help.
  • John Brown on April 19 2018 said:
    GREED, GREED, and More GREED! While I know its totally stupid and totally corrupt I'm rooting for OPEC/Saudi Arabia/Russia to play their game and push oil back to $100. That will both be enough to hammer Global Growth, reducing demand, and set the U.S. shale and offshore oil industries on fire in the USA and elsewhere. I'm still not sure who will invest in Aramco thinking $85 or $100 oil makes it worth more, when the reality is it makes it worth far less, and not in the far future, but the very near future. $80 plus oil is great for the U.S. shale industry and renewable energy. So a little pain with $100 oil now means the future of cheap energy outside of the control of OPEC/RUSSIA get closer faster.
  • Mamdouh G Salameh on April 20 2018 said:
    OPEC is not underestimating US shale oil production. It is the global oil market which is underestimating it having factored it in as more of a hype than a reality.

    While the global oil market is virtually re-balanced thanks to the OPEC/non-OPEC oil production cut agreement, the mission is not, in my opinion, accomplished. It will never be accomplished until oil prices rise to a range of $100-$130, which I describe as a fair price for oil and until the oil market remains balanced permanently. So we don’t want lectures from the IEA about “mission accomplished” having spent its time undermining the oil prices with false claims and hypes about US shale oil.

    Saudi Arabia and the majority of OPEC members should aim for an oil price of $100. To achieve this goal, they have to bolster the current positive fundamentals in the global oil market by extending the OPEC/non-OPEC production cut agreement well into the future. This could be in the form of a permanent mechanism flexible enough to react quickly to a tightening in the oil market or a build in crude oil and gasoline inventories.

    Russia and Saudi Arabia have been the two architects of the OPEC deal and are both committed to long-term cooperation to stabilize the global oil market in their capacity as the world’s top oil producers and exporters.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • Corvettekid on April 25 2018 said:
    MGS, how can you say that the "fair" price for oil is at $100-$130. That is clearly a demand-destructive price.

    The fair price is where the global marginal cost of supply comes from. That price is about $70/bbl. With a 1 standard deviation change in price, that probably means that oil should trade 90% of the time within a band of $60-$80/bbl.

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