The Fuse

The Oil Market’s March Madness

by Matt Piotrowski | March 21, 2017

The global oil markets experienced a sharp sell-off at the beginning of March, but prices have settled back down with NYMEX crude trading just under $50 per barrel. Traders are in a wait-and-see mode regarding whether OPEC will extend its production cuts at its meeting in late May and how well shale will continue to perform as production bounces back. For now, OPEC’s verbal intervention and supply curbs are lending support to the market.

Last week, Saudi Energy Minister Khalid Al-Falih told Bloomberg that OPEC would extend the cuts if oil stockpiles were “still above the five-year average,” a target unlikely to be reached in the next couple of months. His remarks were an example of the now typical case of an OPEC minister jawboning the market with rhetoric to keep prices from falling—as well as a recognition that the cartel will have to continue its course in order to realize its goal of tightening fundamentals. But they also provided insight into the metric that OPEC is apparently trying to reach.

Falih’s remarks were an example of the now typical case of an OPEC minister jawboning the market with rhetoric to keep prices from falling.

While some market watchers have written off the OPEC cut as a self-defeating measure, not everyone falls into this camp. Mike Wittner, an analyst for investment bank Societe Generale, upped his price forecast for the second half of this year, predicting NYMEX to average $58 for Q3 and $60.50 for Q4. His bullish outlooks rests on demand rising by 1.4 million barrels per day (mbd) for 2017 and OPEC cuts more than offsetting the 600,000 barrels per day of non-OPEC supply increases this year. This imbalance will lead to stock draws throughout the second half.

Despite shale’s resurgence, there are questions about how healthy the U.S. E&P sector is in light of higher price levels since November of last year.

OPEC, of course, doesn’t want prices to rise too sharply, however, since that would cause shale to rebound more rapidly than expected. As of now, U.S. crude production is back to 9.1 mbd, the highest weekly average in more than a year, and the rig count, after rising by 14 last week, is up 100 percent since its nadir in May of last year. Despite shale’s resurgence, there are questions about how healthy the U.S. E&P sector is in light of higher price levels since November of last year. As Bloomberg Gadfly columnist Liam Denning points out, the U.S. shale patch is still in the midst of repairing itself. Last year, only four of the 11 major E&P companies were able to raise production, while realized prices fell under $20, versus a peak of $42.50 in 2014. Margins plunged by a whopping 75 percent, Denning notes.

The industry was last year, in the words of Harold Hamm, on the “brink of extinction.” But it’s been saved by two things. One factor has been friendly capital markets—Bloomberg data shows the aggregate leverage for the group jumped from 1.3 times trailing Ebitda in 2014 to 10.4 times in 2016. The other is, ironically, OPEC’s intervention to lift prices. For Saudi Arabia, the side effect of its decision to act: “Suffering rivals in the shale patch can free-ride on such optimism to repair themselves and resume growing,” said Denning.

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