OPEC’s Deal Drives Oil Prices Up a Slippery Slope

 

November 30, 2016 [Organization of Petroleum Exporting Countries, Oil Prices]
Charles Roth


Oil prices jumped sharply in the wake of OPEC’s pact to cut production, but the market might wait to see implementation of the output reduction. OPEC’s quota compliance history and current market supply and demand dynamics don’t necessarily support sharp climbs in oil prices.

Oil prices jumped 10% Wednesday, November 30, in response to the Organization of Petroleum Exporting Countries (OPEC) deal to cut output by 1.2 million barrels per day, around 1% of global production. Is the market getting over its skis?

Organization of the Petroleum Exporting Countries

Perhaps so, particularly if prices continue to rise in the days ahead. Quite apart from OPEC’s history of poor member compliance with self-imposed quotas, the U.S has become the world’s swing producer thanks to the advent of unconventional shale oil production. With crude benchmarks now hovering around $50 a barrel, U.S. shale-oil breakevens at the wellhead are cost competitive.

Two years ago, Saudi Arabia decided to pursue a market share strategy, subordinating prices to supply in a bid to undercut higher-cost U.S. producers, not to mention fellow OPEC members and regional rivals lran and Iraq, along with non-OPEC Russia, which reportedly agreed to a 300,000 barrels per day (b/d) cut Wednesday. Despite a decline in total U.S. output from a peak of 9.6 million b/d in June 2015, shale producers have proven quite resilient and nimble thanks to technology advances, improving well cycle times and a focus on easier production spots. After bottoming at 8.4 million b/d in July of this year, total U.S. output has actually rebounded to around 8.7 million b/d currently. Unsurprisingly, the climb coincided with a roughly 70% jump in U.S. oil prices this year from a low of about $27 a barrel in January.

Meanwhile, U.S. President-elect Donald Trump has vowed to unleash more U.S. energy production and expand associated infrastructure, including pipelines. While that will take some time, easier leasing for onshore and offshore exploration and easier means of getting new oil to market will certainly at some point down the road weigh on oil futures prices.

On the demand side, consumption growth has been slowing in China and parts of the Americas. Then there’s the prospect of compliance with the Paris Agreement on limiting global carbon emissions amid a growing worldwide rise in electric vehicles and especially those that run on compressed natural gas. Rather than long-debunked “peak oil” supply hypotheses, oil majors and even the International Energy Agency (IEA) are starting to look at “peak demand” scenarios, pointing at Western Europe as the starting point for the gradual ebbing of global consumption of oil-based transportation fuels over the next few decades.

In its latest pact, the cartel’s first output cut since 2008, OPEC’s hope is that brimming inventories worldwide will start to recede, reinforcing a view in the industry that supply and demand dynamics would finally come into balance in 2017. Although global economic growth is accelerating modestly, which should spur more consumption, U.S. producers will likely keep adding to global oil supplies. And they’re not the only ones. Kazakhstan’s giant $50 billion Kashagan field has just come on line and, according to the North Caspian Operating Co., which runs the field, is slated to hike output to 370,000 b/d by the end of 2017. In its November “Oil Market Report,” the IEA projected non-OPEC production to increase 500,000 b/d in 2017. But it could well be more with the latest rise in prices.

As the old commodities maxim goes: the cure for low prices is low prices, and the cure for high prices is high prices. Ali al-Naimi, Saudi Arabia’s former, long-time oil minister, said in a recent interview with the Financial Times, “anybody who thinks he or any country is going to influence the price in today’s environment is out of his mind.”

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