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Osama Rizvi

Osama Rizvi

Osama is a business graduate and a student of international relations. Currently working as freelance journalist, covering commodities and geopolitics.Osama is a regular contributor to a variety…

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Are Deeper Cuts OPEC’s Only Option?

Despite the November, 2016 Vienna crude oil agreement among OPEC and certain non-OPEC (NOPEC) producers and its subsequent May 2017 extension, the global crude oil market is still burdened with excess supply and may be far from re-balancing.

“Re-balancing” largely refers to an economic mechanism where a sustainable and stable equilibrium price for a commodity is realized. In the case of crude oil, this rebalancing has historically been achieved by artificially intervening in supply.

While observers may note that the market should be left to re-balance itself, a look at fundamentals suggest that approach may not be feasible or sufficient. Therefore, according to Rex Preston Stoner, an energy consultant with U.S.-based HUB International, “joint action by the OPEC/NOPEC producers may remain necessary for the medium term, if not the long term, if crude is to avoid another price crash. Whether such collective action may hold is the ‘million dollar question’”

Some observers argue that Saudi Arabia made a grave error when in 2014 it chose not to play its traditional role of global “swing producer” and refused to “turn off its taps” just as global demand declined. Market share was at stake and the Saudi action was based on an apparently misinformed calculation that high-cost producers, particularly the U.S. Shale companies, would be forced from the market leaving OPEC producers with their market share restored and the global crude oil price stabilized at a level that could sustain the Saudi and other OPEC producers’ economies.

In the light of rising U.S. production, gains from Libya and Nigeria, and doubts over the effectiveness of the OPEC-led pact oil prices fell clearly indicating that markets require more OPEC intervention.

U.S. Shale production continues to rise, reaching 9.34 million barrels this month, while there is no sign of production abating in Nigeria and Libya, two OPEC member countries exempt from the deal. Libya has ratcheted up its production to 1 million barrel for the first time in four years while Nigerian oil production, including condensates, has increased to 2.025 million barrels per day with plans to increase production further. Lastly, figures show that, while the core OPEC producers adhered to the production caps during April and May 2017, overall OPEC exports have actually risen by more than 2 million barrels per day in June as compared to 2016.

(Click to enlarge)

The U.S. active rig count as tracked by Baker Hughes is a commonly cited barometer of the health of the U.S. oil & gas sector. Last week, the BHI rig count rose by 7 units, making the total number of rigs 763 - the highest since April 2015. At the same time, the recent drops in U.S. oil inventories may not continue following the end of U.S. summer driving season. Related: ‘’U.S. Rig Count Must Drop 150 For Oil Markets To Balance’’

As well as this, global oil producers are gearing up to bring a number of largescale E&P projects online, which will give a boost to the sector – softening global crude pricing. According to Barclays’ E&P spending survey, global E&P expenditures will rise by 9 percent this year compared to 2016. In light of current production and with more projects coming online, the prospect of a continuing glut may be a certainty.

Are there other long-term market developments that will further exacerbate the long-term oversupply of global crude?

According to Bloomberg New Energy Finance (BNEF), electric vehicles will replace about 8 million barrels of oil demand per day by 2040. Meanwhile China – one of the world’s largest consumers of energy - is reportedly turning towards renewables including solar. It has plans to invest almost $361 billion in renewable power by 2020 which by that time would account for approximately half of its electricity generation needs, according to China’s National Energy Administration. According to an April, 2017 report published by BNEF, in collaboration with UN Environment and the Frankfurt School-UNEP Collaborating Centre, “Investment in renewables capacity was roughly double that in fossil fuel generation; the corresponding new capacity from renewables was equivalent to 55 per cent of all new power, the highest to date”.

OPEC intervention was the only mechanism that prevented oil prices from crashing completely. With a compliance rate of more than 90 percent, efforts by OPEC drained 1.8 million bpd from global supply, providing markets with some hope of a price recovery. However, despite the joint efforts of the coalition of OPEC and NOPEC producers to curb output, a desired re-balancing of the global crude oil market is most likely not on the horizon. For observers who ask if the market may reach equilibrium on its own, the apparent answer is a resounding “no,” as the global oil market, if left to itself and as indicated by market fundamentals, will likely generate further volatility.

Therefore, seasoned observers may be looking at Saudi Arabia to do more in urging its fellow producers to respond during the coming July 24th meeting. Deeper productions cuts, while painful in the short-term, may be the only long-term solution.

By Osama Rizvi for Oilprice.com

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