Another False Alarm For An Oil Price Recovery?

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The Organization of Petroleum Exporting Countries (OPEC), along with some non-OPEC countries, met in Abu Dhabi last week in order to review the status of compliance of the oil production quotas by member countries. While the meeting did not result in an increase in the existing output cuts of 1.8 million barrels per day (Mbpd), the cartel managed to get the reaffirmation from Iraq, Kazakhstan, United Arab Emirates (UAE), and Malaysia regarding their full conformity with their respective supply cuts. The news, just like the previous OPEC meeting in late May 2017, failed to have a lasting influence on the crude oil prices.

To top this, the US oil production has magnified to 9.4 Mbpd earlier this month, marking its highest production in the last 29 months. Further, the global rig count continues to grow and has crossed the 2,100 unit mark for the first time since September 2016. This clearly indicates the rising demand for drilling and exploration activities worldwide, particularly in the US, which is likely to further weigh down oil prices in the coming months. Thus, despite the oil cartel’s efforts to provide reassurance to the investors, we do not foresee a full-blown recovery in oil prices anytime soon.

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Quick Recap

The year 2017 began at a high note for the energy sector, as Brent oil prices crossed the $55 per barrel mark in February this year on the back of the 1.8 million barrel per day (Mbpd) production cuts announced by the OPEC and some non-OPEC members. This caused major oil and gas producers, such as Anadarko Petroleum and EOG Resources, to increase their capital and exploration budget drastically for the year to leverage the anticipated recovery in commodity prices. The surge in the drilling and exploration demand, in turn, led to a sharp rise in the global rig count (oil as well as gas) from 1,772 units at the beginning of 2017 to 1,985 units at the end of March 2017. In consequence, the US oil production and inventories grew steadily from 8.9 million barrels of oil per day (Mbpd) at the time of the announcement of the OPEC deal to 9.1 Mbpd at the end of the March quarter. This partially nullified the impact of the supply cuts by the OPEC members, causing a panic wave among the investors, which sent the oil prices below $50 per barrel yet again in April of this year.

However, since the OPEC members and their economies have been distressed due to the prolonged weakness in commodity prices, the cartel members extended their output cuts until March 2018. Although it was expected that the move would augment the rebound in oil prices, the market did not move positively on the news as the investors feared the non-compliance from the OPEC members and increased supply from the US shale producers to mitigate the impact of the OPEC production cuts. Unfortunately, the investor fears came true as the global rig count rose to 2,041 units at the end of the June quarter, resulting in a steep jump in the country’s oil production. The US production stood at 9.3 Mbpd at the end of June, implying an increase of 7.4% since the finalization of the OPEC deal in November 2016. As a result, Brent oil prices were pushed below $45 per barrel, shattering the hopes of an oil price recovery in 2017.

Source: US Energy Information Administration (EIA)

Current Situation

Rising US production and inventories

On the positive side, the US oil stockpiles have dropped from 2,038 million barrels in November 2016 to 1,991 million barrels as of today. However, a mere decline of 2% in the overall US inventories is unlikely to initiate a recovery in the oil markets. On the contrary, the US oil production, as stated earlier, continues to expand swiftly and has reached 9.4 Mbpd at the beginning of this month. Further, the global rig count has strengthened over 10% since the beginning of the year, and averaged at 2,110 units for the month of July. Interestingly, the US rig count has grown much faster than the global rig count over the last six to eight months. The US (excluding Canada) rig count currently stands at 953 units, almost 40% higher on a year-to-date basis. This suggests that the US shale producers have reinstated their production capacities and are likely to continue to grow their output to benefit from the improved oil prices. In turn, we expect to witness a fall in crude prices in the forthcoming quarters.

Source: US Energy Information Administration (EIA)

Fear of non-compliance

Despite the OPEC’s repeated efforts to ensure reduction in global oil supplies, ensuring complete conformity by the member countries continues to be a challenge for the cartel. Prior to the meeting in Abu Dhabi last week, the OPEC is believed to have met Iraq and UAE separately to ensure their compliance to the production quotas. While the two countries have reaffirmed their loyalties to the OPEC cuts, the production numbers paint a different picture. For instance, Iraq’s oil production stood at 4.55 Mbpd at the end of June, higher than its targeted output of 4.35 Mbpd decided under the deal. Similarly, the UAE produced 2.98 Mbpd of oil in the month of May, more than its target of 2.87 Mbpd as per the OPEC agreement. Further, Kazakhstan, which had agreed to cut 20,000 bpd of its oil output under the deal, last month announced that it would increase its oil production. However, last week the oil cartel announced that the country has reaffirmed its compliance with the output cuts.

Given the lack of appropriate measures to keep a check of the output numbers, it is difficult to ascertain the level of compliance by the OPEC and non-OPEC members. Hence, it is easy for these countries to have their way and continue to over produce despite remaining a party to the OPEC deal. This is likely to cause an unrestrained surge in oil supplies globally, pulling down the oil prices further in the coming months.

See Our Forecast Model For Crude Oil Prices Here

Our Take

Having engulfed several oil and gas companies across the globe, the worst-ever commodity downturn has entered the third year of its devastation. On one hand, the OPEC is taking all measures to ensure adherence to production cuts to stabilize oil prices. On the other hand, the US shale producers are pumping large amounts of oil in order to benefit from the improvement in oil prices. As a net result, we expect the rising US production, coupled with some non-compliance by the OEPC members, to result in a drop in oil prices in the coming months. Although the commodity markets have shown strong signs of recovery a few times in the last year or so, the rebound in oil and gas prices to the pre-downturn levels seems like a far-fetched dream now. Based on our estimates, Brent oil prices are expected to average in the range of $48-$50 per barrel for the full year 2017.

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