The Revival Of Crude Oil Prices Appears To Be A Distant Dream

The optimism that had filled the commodity markets due to the OPEC’s resolve to rebalance the oversupplied oil markets has now transfigured into cynicism. After moving past the $55-per-barrel mark for the first in the last 20 months in February of this year, crude oil prices have plunged back to under $45 per barrel of late. This collapse is largely driven the incessant rise in the US oil production and inventories, as the sudden recovery in oil prices has made it economically viable for US shale producers to expand their output. Additionally, the global rig count, more specifically the North American rig count, has been expanding sharply, indicating that the US oil output is likely to swell even further in the forthcoming months. To top it all, as per the latest data, the OPEC members, particularly Nigeria, Libya, and Iraq, have ramped up their output in the last month, raising questions about the effectiveness of the oil cartel’s production quotas. This could imply that despite the OPEC’s efforts to curb its oil supply, and in turn, stabilize oil prices, the oil prices are likely to remain depressed over the short term.

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Continuous Rise In US Oil Supply Will Hamper Recovery

One of the positive outcomes of the ongoing commodity slump has been the reduction in the operating costs of most of the US shale producers. While a dozen of these companies have been pushed out of the market in the last two years, a few of them, such as EOG Resources and ConocoPhillips, who have continued to optimize their cost structures and invest in innovative technologies to enhance their operational and capital efficiency, have managed to bring down their break-even oil price from over $80 per barrel in 2014 to under $40 per barrel at present. This has motivated independent oil and gas producers, such as Chesapeake and Anadarko Petroluem, to build extensive plans to grow their production by 10%-15% annually over the remaining years of this decade.

Source: US Energy Information Administration (EIA)

That said, the already saturated oil markets have started experiencing the strain of the growing influx of oil output from these US energy companies. To put things in perspective, the US oil production has gone up from 8.7 million barrels of oil per day (Mbpd) at the time of the OPEC deal to 9.33 Mbpd at present, representing a jump of more than 7% within a span of six months. The majority of this rise is driven by the increased drilling activity in the North Dakota, Oklahoma, Permian, and other shale regions. According to Bloomberg, there were 5,946 drilled-but-uncompleted wells in the US at the end of May, which is the highest in the last three years((Shale’s Record Fracklog Could Force Crude Prices Even Lower, 19th June 2017, www.bloomberg.com)).

In addition to the production, the US oil stockpiles have also been accentuating the global oil glut. Currently, the US crude oil inventory stands at 1,196 million barrels, which is similar to what it was at the same time last year. Although the country’s oil stock has been declining over the last couple of months, it continues to be higher than the pre-OPEC deal levels. In fact, it is more than 9% higher compared to the nation’s average oil stock in the last five years, defeating the oil cartel’s attempt to draw down the excess oil supply from the global markets.

To make things worse, there is a high probability that the US oil output will continue to multiply. Since the OPEC’s decision to hold back their cumulative oil output in November 2016, the global rig count (oil and gas) has risen by over 15%, and currently stands at 1,935 units. However, the US rig count has grown by almost 30% to 978 units during the same period. Given the compounding demand for rigs backed by aggressive production targets of US oil producers, we forecast the country’s oil production to shoot up further in the coming months, which is likely to pull down oil prices.

Default By OPEC Members Could Vandalize The Cartel’s Efforts

At a time when the market experts are blaming the expanding US oil supply for the delay in the rebound of oil prices, the latest data from the OPEC’s Monthly Oil Market Report (MOMR) indicates that the cartels’ oil production, which was supposed to decline as per its agreement, has grown by 336 thousand barrels per day (kbpd) for the month of May. While most of the member countries continued to keep their output in check, Iraq, Libya, and Nigeria have increased their oil production by more than 6% during the month, which is the key reason behind the rise in the OPEC’s output.

Source: OPEC Monthly Oil Market Report, 13th June 2017 

As of now,  Nigeria and Libya are exempt from any production quotas under the OPEC’s deal. However, since the oil produced by the two countries suffered severely in the last year due to the geo-political unrest in their economies, they are now beginning to regain their lost market share by ramping up their output.  The jump in the OPEC’s oil production has caused the market experts to probe the validity of the cartel’s deal. If the oil supply from these countries continues to rise at this rate, there are chances that the other member countries decide not to adhere with the current production cuts, and/or demand for favorable terms under the deal. This would diminish the impact of the cartel’s production cuts, if not completely nullify it, and in turn, force the oil prices to plunge again, and prolong the worst-ever commodity downturn.

Given the strong drilling demand in the US, the oil supply from the country is likely to increase sharply in the coming quarters. This, coupled with rising oil output from the OPEC members that are exempt from the production cuts, could negate the oil cartel’s efforts to normalize oil prices over time, and on the contrary, result in further weakness in oil prices at least in the near term.

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