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OPEC Deal Extension Looks Shaky As Shale Hedges Production

Desert oil

You’ve got to feel for the guy who hit ‘Send’. That statement would have been written, read by a committee, re-written with countless minor words removed or added before finally being agreed and getting signed off. You can almost hear the shout of ‘Hang on!’ that erupted the very second the press officer hit the button.

The first statement from the joint committee of ministers from OPEC and non-OPEC oil producers reported “a high level of conformity and recommends six-month extension (of the voluntary oil production cut).” Great news – very clear – got it.

The final statement said the committee had only decided to “review the oil market conditions and revert.. in April 2017 regarding the extension of the voluntary production adjustments.” (In the interim period, said press officer was also likely searching desperately for a credible reason why there had been such a drastic change, and a source explained to the media later that the committee simply didn’t have the legal mandate to recommend the extension…)

Now, had this been the initial statement, it would have been viewed as an altogether positive move. But it wasn’t, and so it is clearly a cautious step back from that position. As such, the markets will react. As Reuters.com reports, Harry Tchilinguirian, head of commodities strategy at BNP Paribas said, "The dropping of the recommendation to extend cuts in favour of technical review committee is likely to lead to a lot of disappointment and potential further liquidation of long positions by money managers that will put downward pressure on oil prices.”

Related: Saudi Arabia Alters Oil Pricing To Attract European Buyers

It’s been just over five months since the deal was agreed upon by the leading oil producers to reduce output. Originally, it was to last six months, resulting in a drop of 1.8m bpd, but there was always the possibility of an extension. At the end of this term, all the signees to the deal have yet to fully embrace the agreement, though Russian Energy Minister Alexander Novak was quoted as saying there was “94 percent compliance”, and this was addressed in the statement with the committee saying it “encouraged all participating countries to press on toward 100 percent conformity.”

But unfortunately for OPEC, it doesn’t hold all the cards in this game. There is the matter of the U.S. to consider. Recently, crude oil stock piles have increased, with the committee acknowledging low seasonal demand, refinery maintenance, and rising non-OPEC supply.

Shale is having a whale of a time at the moment– especially in the Permian Basin. CNN Money put it sweetly – it has “emerged as the new poster boy of the U.S. shale oil revolution”. The price of land in the Permian Basin keeps going up, drilling activity has tripled, and production is reaching record highs. This area alone is predicted to enable overall U.S. production to soar to a new record level in 2018. CNN explains that, “The key is that the unique geology of the Permian allows frackers to hit multiple layers of oil as they drill into the ground. That's what sets the Permian apart from other major oilfields, making it lucrative to drill there even at today's sub-$50 prices.”

Related: Is An Iraqi Production Slowdown Inevitable?

U.S. drillers have been thinking long-term, as well. Data from Wood Mackenzie shows that shale drillers are now insulating themselves against falling prices. 33 percent of the largest producers have 26 percent of their output hedged – meaning they have the option to sell oil at an agreed-upon future price. As CNBC.com reports, the hedging looks like a smart decision. “Oil process have dipped back below $50 in recent weeks on concerns about rising US production, particularly in the Permian Basin…”. It quotes Helima Croft, global head of commodity strategy at RBC Capital Markets, who told ‘Squawk on the Street’, “One thing OPEC has to worry about is if they don’t extend the production cuts, a lot of that Permian production was hedged when oil was in the mid $50s. Even if we fall back further, that production is coming on.”

There is an awareness, however, of consequential repercussions. As ClipperData reported, “"There is concern that U.S. production is going to come roaring back so much that it impedes the price recovery. This is a vicious cycle” and Rob Thummel, a portfolio manager at energy investment firm Tortoise Capital noted, "There's no doubt we've got too much oil. We're trying to figure out how to balance through that." Therein lies the key. Whether anyone has the ability to follow this through is the big question.

In the battle of sheiks versus shale, it’s never dull.

By Precise Consultants

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