Will Oil Prices Move Out Of The Goldilocks Range Of $45-$55 Per Barrel Post The OPEC Meeting?

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Having crossed $55 per barrel earlier this year due to the production cuts implemented by the Organization of Petroleum Exporting Countries (OPEC), crude oil prices have been oscillating around the $50-per-barrel mark over the last couple of months. The major reason behind this increased volatility in oil prices is the rising US shale oil production and inventories (For more details read: Here’s Why Crude Oil Prices Have Dropped For The First Time Since The OPEC Deal). While at first the market was skeptical about the OPEC members adhering to the terms of the agreement, some of the cartel members have strongly complied with the production quotas, causing the oil prices to rebound sharply in the first quarter of the year.

However, the OPEC move to improve oil prices was not augmented by the US shale producers. The supply cuts caused the oil prices to hover between $50-$55 per barrel for a sustained period, making it financially viable for US tight oil producers to reinstate, and in some cases even expand, their production activities. Consequently, the market witnessed a gradual increase in the country’s oil output over the last few months, particularly in the North Dakota, Oklahoma, Permian, and other shale regions. The US oil production stood at 9,305 thousand barrels per day (kbpd) last week, which is nearly 7% higher compared to where it was in November 2016, when the OPEC deal was announced.

Oil-OPEC

Data Source: US Energy Information Administration

On similar line, the US oil inventories have also been on a rise since the OPEC members agreed to restrict their oil supply. Though the US stockpile dropped sharply in December 2016, it recoiled steeply in the early months of 2017 due to the annual shutdown of refineries for maintenance purposes. However, even after these refineries became operational again, the markets have not seen a considerable decline in the US oil inventories, as was expected by the industry experts. In fact, the US oil stock currently stands at 2,028 million barrels, merely 0.5% lower compared to the inventory levels at the time of the announcement of the OPEC deal.

This has not only increased the volatility in the commodity markets, but has also left the investors wary of the recovery in oil prices. To add to this, the global rig count, both oil as well as gas, has been growing gradually since June 2016. The global rig count, dominated by the growth in the US drilling demand, has increased more than 14% in the last six months, crossing the 2,000 units mark after almost 14 months. Although the overall rig count witnessed a small drop due to the fluctuations in the commodity markets, the US rig count continues to recover strongly. The country’s rig count has risen almost 47% to 853 units since November of last year. This rise, when viewed in concurrence with the rising US oil output, indicates that the reduction in OPEC supply has stimulated the rebound of the US oil supply, rather than creating a dent on the large oil glut in the global markets.

Oil-OPEC-1

Data Source: US Energy Information Administration

Besides, the prolonged weakness in oil prices continues to bother the oil-driven economies of the OPEC members. Consequently, despite the production cuts being wiped out by the increasing US supply, Saudi Arabia, the largest producer and defacto head of the OPEC, along with Russia, has shown its willingness to extend the proposed 1.8 million (bpd) supply restrictions until March 2018. This nine month extension is longer than the optional six-month extension proposed in the deal, and implies that the strengthening of the oil prices is much more crucial for these countries as opposed to defending their market share in the current scheme of things.

While the news of the world’s two largest oil producing countries planning to restrict their output led to a 2% rise in the oil prices earlier this week, the rally was remarkably lower compared to the one experienced last year post the announcement of the actual deal. This weaker-than-expected response to the announcement could be driven by the market perception that it would be difficult to get all the parties to concur to the same terms of the deal. For instance, Kazakhstan, who was earlier part of this deal, is unwilling to support the production cuts unless their restrictions terms are eased. Further, countries like Nigeria and Libya, who were exempt from the deal, are likely to ramp up the oil production sharply as their financial and geo-political conditions improve, offsetting the impact of the production cuts by the other cartel members.

See Our Forecast Model For Crude Oil Prices Here

On the brighter side, however, Iraq, Iran, the United Arab Emirates (UAE), Kuwait, Venezuela, and Algeria have shown the inclination to support the extension of the production cuts, assuming that the other countries follow suit. Although most of the OPEC members seem to be on-board with the decision to further the output quotas, there have been no indications of increasing the amount of production cuts by the cartel yet. While it appears to be a herculean task to convince all the member countries to agree for higher cuts in the light of rising US production and inventories, one cannot rule out the possibility of deeper reductions at the OPEC meeting in Vienna, Austria on 25th May 2017, which will decide the course of crude oil prices for at least the next few months.

Our Take

In line with the market expectations, we believe that the OPEC will succeed in implementing the extension of its production cuts until March 2018. However, despite this move, we expect crude oil prices to remain in the goldilocks range of $45-$55 per barrel over the next few months. This is because the US shale producers have managed to bring down their break-even prices significantly over the last two years with the use of advanced technology and cost reduction initiatives. Consequently, as soon as the oil prices move upwards of $55 per barrel, it becomes profitable for US shale producers to operate and produce more. This causes the oil supplies to expand, pulling down the oil prices back into the goldilocks range.

While there is still some time before either of the two — the OPEC or the US tight oil producers — manage to completely push the other out of the market, we believe that the days of $100 per barrel oil are long gone.

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