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Osama Rizvi

Osama Rizvi

Osama Rizvi is an Economic and Energy Analyst with a special focus on commodities, macroeconomy, geopolitics, and climate change. He has written for various print…

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Oil Price Tug Of War

Since the Vienna oil deal (30th December) oil prices have been in a game of tug-of-war. On one side is the optimistic viewpoint in the form of production cuts and its compliance. The meeting on 21st of January between the oil producers further bolstered that positivity. This week, Russian oil minister Novak said that 1.4mbpd has been taken of the global markets.

On the other side rests the shale giant. Right after the deal was struck between OPEC and NOPEC producers, analysts and experts started weighing the possibilities. In any case it was anticipated that any cut in production resulting in increasing crude prices would definitely call for a surge in U.S. production. OPEC didn’t have to wait long as this phenomenon is already happening, U.S. frackers have added a significant number of rigs in the past weeks and as a result, U.S. oil production has increased about half a million barrels per day since mid-2016, touching 8.96 mbpd.

In this tug-of-war, both the sides are commensurately strong and influential. One is bullish the other bearish for the oil prices. Mr. Trump right after stepping into the White house has signed a flurry of ‘executive orders’. Perhaps the most relevant one to oil prices, was the resurrection of Dakota Access and the Keystone XL pipeline. Oilprice.com recently covered the effects these pipelines would have on regional oil prices, attractiveness of connected shale basins such as the Bakken and the increase in U.S. oil production. “The pipeline will eliminate the need for 500 to 740 rail cars and/or more than 250 trucks needed to transport crude oil every day.”

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As a result, the Dakota Access Pipeline would not only add takeaway capacity for the Bakken, but it would also trim the transit costs, theoretically making the entire basin more economically viable. This would no doubt translate to higher capital expenditure from upstream companies, higher rig counts, more drilling and ultimately increased oil production, a reporter for Oilprice.com said. Moving oil by train costs around $5 per barrel more than moving it by pipeline. So in the mid-term, the completion of these pipelines and others, which may follow, will definitely add to U.S. production. Related: Is Iran Planning On Breaking Its OPEC Pledge?

The prospect of leasing more federal lands coupled with the OPEC installed price floor could add up to be a perfect recipe for U.S. Shale to undermine the Vienna Oil Deal. To quote Mr. Gaurav Sharma, who says in an article in Forbes: According to Fitch data, the Permian shale basin continues to exhibit considerable activity and has seen valuations rise on an acreage and drilling location basis. “Average acreage values are up about 50% from the first half of 2016 to over $35,500 per acre, while average drilling location values are up 57% to $2.2 million, with some approaching $3 million per location,” the ratings agency wrote in a recent client note, although it did add a caveat that “evidence of acreage flipping suggests valuations could be getting overdone, introducing the potential for lower full-cycle returns.”

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Another, perhaps underestimated factor is the proposed border tax, which if implemented will increase U.S. output, according to some estimates by more than 1 million barrels per day. Bloomberg reports, “Goldman Sachs (in a report) estimated that, at a 20 percent tax rate and current Brent crude oil prices, West Texas Intermediate might immediately swing to a premium of $10 a barrel. Under this scenario, Goldman forecasts U.S. oil output might rise by 1.5 million barrels a day in 2018, almost double its current projection”.

Another underappreciated fundamental is the prospect of a stronger U.S. dollar. President Trump’s ambition to usher in an era of low taxes and less regulations, is another bearish signal for oil prices. The The U.S. Federal Reserve Bank has already communicated the idea of 3 interest rate hikes this year. Related: Saudis Raise March Crude Prices For All Customers

On the bullish side, apart from the production cuts, is the nearing summer driving season (April – September) which will certainly increase gasoline demand as millions of American take to the highways for summer vacations. “This year, the seasonal upside could be even greater than normal. With the lowest U.S. unemployment rate since before the recession of 2008, and two consecutive years of record SUV and light truck sales in 2015 and 2016, the coming summer driving season is likely to show records for miles driven and gasoline demand. In fact, there has been a record number of miles driven every month since December 2014. And a continued trend higher in the 12-month moving total of U.S. miles driven is likely to continue throughout 2017”, Bloomberg observes. While this may provide a short-term cushion for oil prices, gasoline inventory levels are currently still above the 5 year average.

But as far as production cuts and compliance is concerned, as of now, the near-term outlook for oil looks relatively bright. It remains to be seen, however if OPEC is willing to extend its production cut deal in May, when the cartel is meeting. Mr. Khalid Al-Falih has already signaled that there will be no need of any further production deal as the production cuts will absorb all the excess supply.

By Osama Rizvi for Oilprice.com

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