The OPEC Elixir Wasn’t Potent Enough

Friday May 26, 2016

In the latest edition of the Numbers Report, we'll take a look at some of the most interesting figures put out this week in the energy sector. Each week we'll dig into some data and provide a bit of explanation on what drives the numbers.

Let's take a look.

1. Oil market unimpressed with OPEC extension

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- OPEC extended their cuts for another nine months, and put on a display of unity both amongst each other and with non-OPEC countries like Russia.

- However, because OPEC has routinely tried to talk up oil prices with hints of aggressive action, the deal was somewhat disappointing for the markets. Prices sold off on Thursday as there appeared to be nothing more than an extension.

- Rumors surfaced that the group was discussing a 12-month extension, or deeper supply cuts. But with just a nine-month extension, oil traders were left deflated.

- "The market seems to be a bit disappointed as there is no 'something extra' the markets waited for," Jan Edelmann, a commodity analyst at HSH Nordbank AG, told Bloomberg. "It seems as though OPEC fears letting the stock-draw run too hot."

2. Iraq posts unimpressive compliance

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- Getting Iraq on board with the initial OPEC agreement was key, and securing their commitment for a nine-month extension was also one of the biggest hurdles.

- But Iraq's approval of both does not necessarily translate into production cuts. Iraq had the worst compliance rate over the first three months of the deal, missing its target by 80,000 bpd.

- Going forward, Iraq has stated its objective of ramping up production capacity to 5 million barrels per day (mb/d) in the second half of 2017.

- That stands at odds with a production cap of 4.35 mb/d. If Iraq truly achieves the ability to produce 5 mb/d, it will be difficult to restrain output by so much.

- That bears watching because Iraq's "cheating" could not only undermine the efficacy of the OPEC deal, but also threaten to push other members into cheating.

3. OPEC succeeded in boosting sentiment

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- Even if the first six months of the OPEC cuts failed to normalize crude oil inventories, it did succeed in creating bullish sentiment regarding oil prices.

- In the first few months of 2017, hedge funds and other money managers staked out a record bullish position on crude futures.

- But speculators may have gone too far, and in late April and early May that led to a sudden drop in front-month oil prices.

- However, with OPEC extending its production cuts, bullish bets are on the rise again, which suggests near-term gains in prices.

4. OPEC still making money

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- OPEC was faced with a dilemma. Letting the market sort itself out risked crashing prices again but keeping the cuts in place for longer than expected would mean more sacrifice. That seemed like an especially painful choice given the slow pace of inventory declines.

- But the only metric that really matters for OPEC is revenues. "Make no mistake, it is all about oil revenues," Bhushan Bahree, a senior director at consultant IHS Markit, told Bloomberg. "The bottom line for oil producers begins, unsurprisingly, with a dollar sign and ends in billions."

- OPEC countries earned an additional $75 million per day in 1Q2017 compared to 4Q2016, despite having to ostensibly cut 1.2 mb/d. That shows that despite having to cut back on output, the group nonetheless took in higher revenues because of the higher prices.

- A return high production levels would mean more barrels sold, but likely at much lower prices. In the end, the choice was not difficult.

5. OPEC needs to scare U.S. shale away

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- Goldman Sachs warned that the oil glut could return in late 2018 once the OPEC deal expires.

- If OPEC producers go back to full production, and U.S. shale grows at "an unbridled" rate, the oil market will suffer from yet another glut.

- Goldman says OPEC needs to scare away U.S. shale by lowering futures prices with talk of higher long-term production.

- The growth of U.S. shale depends heavily on the expected price of WTI next year. Goldman says that at $55 per barrel, U.S. shale could add 1 million barrels per day. But at just $45 per barrel, shale will add less than 250,000 bpd.

6. SPR selloff

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- As part of his recently released budget proposal, President Donald Trump wants to sell off crude oil from the U.S. strategic petroleum reserve (SPR), the world's largest.

- The goal of the SPR is to hold at least 90 days' worth of supply in the event of an outage. Energy analysts have cautioned against getting rid of the stockpile for security reasons.

- But Bloomberg Gadfly notes that even if the government starts to unload crude from the SPR, because U.S. oil imports have declined substantially over time (and because of rising domestic production), the smaller SPR would still cover more and more days' worth of supply.

- For example, in 2006, the SPR only had 60 days' worth of supply in it. But by 2018 - even after selling off 34 million barrels from the SPR in 2017 and 2018 - the SPR will hold a whopping 180 days' worth of supply.

- On top of that, commercial stocks add another 300 days' worth of supply.

- For this reason, the political and national security value of the SPR in Washington is declining.

7. Natural gas demand soaring in China

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- China's natural gas demand rose 12 percent in the first four months of 2017 compared to a year earlier. For the month of April, consumption jumped by 22 percent, year-on-year.

- Natural gas is still a small part of the electricity mix, as China is the world's largest consumer of coal. But the government is in the midst of an ambitious effort to shutter coal plants in order to improve air quality. Such a plan relies heavily on natural gas.

- The Chinese government is actively pushing gas as a matter of policy, aiming for gas to capture ten percent of total energy consumption by 2020. That would translate to demand growth of 13 to 15 percent annually going forward.

- The future is bright for natural gas in China, even as it is still expensive. China is trying to spur shale gas production domestically, but it is also importing ever larger volumes of LNG from abroad.

That's it for this week's Numbers Report. Thanks for reading, and we'll see you next week.