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What’s Behind The New OPEC Skepticism?

Rig

OPEC+ took action to cut supplies from the market last week and threw themselves and U.S. frackers a substantial short-term lifeline. In terms of price action, the 1.2m bpd cut (to begin in January) seems to be mostly in line with what the market expected as Brent crude has flattened out near $60/bbl.

The tepid price movement following the announcement of the deal highlights both the bloated status of physical balances as well as the market’s expectation that U.S. producers will comfortably be able to keep a lid on prices in the near term. Traders are highly reluctant to resume the bullish enthusiasm they felt in early 2018 and have kept time spreads securely in contango. Analysts seem to feel similarly with the EIA reducing their 2019 Brent forecast to $61/bbl while Citi sees Brent trading in a $55-$65 range next year.

Market skepticism related to OPEC and OPEC+ production cuts isn’t new. Decisions made by the group to balance oil supplies with demand have always been met suspiciously as traders have questioned whether the group would actually self-impose the cuts they agreed to. This was certainly true the last time cuts were made in 2016 and prices slowly adjusted higher as data revealed that the group was highly disciplined in hitting quotas. What seems strikingly different this time around, however, is that the skepticism related to OPEC+ cuts seems to be that they lack the efficacy to shock the market higher because so many of the cut barrels will be replaced by North American producers. Traders seem to take it at face value (amazingly!) that the cartel will reduce production by more than 1m bpd, but it doesn’t seem to be injecting a high degree of bullish risk into the market. Instead, options markets, time spreads and hedge fund positioning all seem preoccupied with the bearish risk created by the Trump/Xi trade war, record U.S. crude production and the maturation of the global economic expansion.

Markets are correct in wearing a bearish concern related to U.S. producers. U.S. crude output has averaged 10.75m bpd in 2018 representing a 1.4m bpd y/y increase and a 2m bpd increase from 2016. Increased/flat prices- a gift from OPEC- should allow more producer hedging for 2019 and 2020. WTI 2019 and 2020 calendar swaps both traded near $52/bbl this week and we expect to see incremental hedging from producers near $55/bbl and $60/bbl which should ultimately weigh on prices.

The extent that the market narrative…




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