Here’s Why Crude Oil Prices Have Dropped For The First Time Since The OPEC Deal

by Trefis Team
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The year, 2017, began on a happy note for the low-spirited oil and gas industry, as the commodity prices finally displayed signs of a sustained rebound for the first time since the onset of the commodity slump in mid-2014. Crude oil prices had been trading above the prominent $50 per barrel mark since December of last year, after the Organization of Petroleum Exporting Countries (OPEC), along with some Non-OPEC countries, had agreed to bring down the global oil surplus by 1.8 million barrels per day (Mbpd), in order to correct the dwindling commodity prices. This revived the optimism among the oil and gas players as well as the investors, leading them to believe that the worst-ever commodity downturn had finally come to an end. However, this relief was short-lived for the industry, as oil prices dropped more than 8% in the last 10 days. Below, we briefly discuss the reasons behind this sudden dip in oil prices.

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Source: US Energy Information Administration (EIA)

Rising US Crude Oil Inventory

As the market had anticipated, the recovery in oil prices due to the expected production cuts by the OPEC has enticed the US oil and gas producers to resurface their drilling and production activities, causing a rise in the US crude oil stockpile. According to the weekly data released by the US Energy Information Administration (EIA), the US oil inventories stood at 1,222 million barrels for the week ended on 10th March 2017. Although the inventory has dropped marginally compared to the previous week, it is significantly higher for this time of the year. At the same time last year, the US oil stock was 1,187 million barrels, 35 million barrel lower than the current levels.

While the shutdown of refineries for annual maintenance is one of the major reasons for this stock buildup, the sudden surge in the US oil production on the back of improving commodity prices is a key driver of the jump in the oil inventories. An increase in the crude inventories generally indicates weaker demand and/or over-supply of oil, creating a bearish market for crude prices. This is clearly visible from the slide in crude oil prices from over $53 per barrel earlier this month to less than $48 per barrel, post the announcement of the inventory numbers.

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Sudden Surge In US Production

Over the last year, the depressed commodity prices forced several US oil and gas producers to reduce their output in order to sustain their operations. As a result, the US oil production dropped from 9,220 thousand barrels per day (kbpd) at the beginning of 2016 to roughly 8,400 kbpd by mid-July of 2016. However, with the OPEC announcing its plans to cut down its oil output to reverse the slide in oil prices, commodity prices rose sharply, improving the bleak outlook of the industry.

While the market was skeptical about the OPEC members abiding by the production quotas, some of the cartel members have strictly complied to the terms of the deal, resulting in a drop in the overall OPEC oil supply in the last two months. This strengthened the investors confidence in the rebound of the commodity markets, causing the oil prices to reach $55 per barrel in the last couple of months. However, this bounce back in oil prices made it economically viable for several US oil and gas producers to produce oil at above the $50 per barrel price. As a result, the market saw a gradual increase in the US oil output over the last few weeks, as producers expanded their crude oil production in North Dakota, Oklahoma, Permian, and other shale regions.

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As of 10th March 2017, the US crude oil production was 9,109 kbpd, very close to where it stood a year ago. This implies that the reduction in US oil supply in the last year has been completely wiped out, and the drop in OPEC supply has been replaced by the US supply. Further, since the demand for oil has not improved significantly in this time, this has reinstated the supply-demand mismatch in the oil markets. In consequence, the WTI oil prices have been declining in the last few days, and are currently trading below $50 per barrel.

Our Take

Looking at the current scenario, we believe that oil prices will continue to oscillate in the $45-$55 per barrel range over the next few months. This is because as soon as the oil prices stabilize at a point between $50-$55 per barrel, it would prompt US tight oil producers to reinstate their output, since it would become economically viable for them to produce more oil. This would, in turn, increase the supply of oil in the global markets, causing the oil glut to grow again. Consequently, the impact of OPEC’s move to cut output will be diluted, and lead to a drop in oil prices. Thus, the OPEC and US tight oil producers will continue to maneuver their output to push the other one out of the market. It remains to be seen who will win this battle.

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