The Fuse

OPEC’s Conundrum Continues

by Matt Piotrowski | March 27, 2017

At an OPEC committee meeting this past weekend in Kuwait, representatives from member nations, along with some non-OPEC producers, touted the high compliance rate of just under 100 percent and argued that an extension of output cuts would bring about their market goals for the second half of the year, but stopped short on agreeing on a new initiative.

That news should have supported prices, but it didn’t. Oil prices fell again on Monday morning, with NYMEX crude futures now holding around $47-$48 per barrel.

The market’s initial reaction on Monday and its losses of about $7 since the beginning of March indicate that OPEC members can’t use verbal intervention to lift prices as easily as last year. Over the past 14 months or so, when ministers talked of freezing or cutting production, their rhetoric was an effective tool to manipulate prices. “We would see the relative lack of reaction in the price perhaps as a reflection of some disappointment that nothing more concrete was forthcoming, as well as the market’s increasing skepticism that either a rollover of the cuts can be agreed or that it would have a lasting and significant impact on balances,” said analysts at Vienna-based JBC Energy in a note.

The reality of global oil market fundamentals is getting in the way of OPEC’s verbal intervention.

The reality of global oil market fundamentals is getting in the way of OPEC’s chatter. U.S. production has surged by about 400,000 barrels per day since OPEC agreed to its cuts, offsetting about a third of the cartel’s curbs, and more output in the shale patch is on the way. The U.S. EIA sees annual output growth of 630,000 b/d in the fourth quarter. Against this backdrop, speculators have liquidated bullish bets, another reflection that many market watchers and participants see OPEC’s actions as toothless.

jbc1

Although agreement on an extension of the cut in May, which will have to include non-OPEC participants, is not a foregone conclusion, many in OPEC want to double down on their strategy in the hope that the second half of the year will bring tighter fundamentals and the loftier prices members want, even with shale’s rebound. “We expect the stock overhang to be withdrawn starting from the third quarter; hopefully by the end of the year, we should see a rebalancing of the market,” said Issam A. Almarzooq, Kuwaiti oil minister and the chair of the committee to monitor compliance.

All of the current bearish news, of course, does not necessarily mean that OPEC’s cut will inevitably fail and that the cartel won’t see its desired results, even if they occur later than originally expected. A number of analysts, like the optimistic OPEC members, see the tide turning during the second half of the year. Michael Cohen of Barclays said the recent downturn in prices is just a “short-term blip” and the market is due for a “constructive correction,” while Amrita Sen of Energy Aspects predicts $60 during the second half of the year.

OPEC’s conundrums are now the consequence of its own making, for failing to let the free market set the price.

The starkest warning comes from Goldman Sachs, whose analysts say that, despite high U.S. crude inventories, the global market’s rebalance is already in progress. Should OPEC extend its cuts, prices could overshoot to the upside. “We … believe that OPEC should be wary of extending its production cuts,” said Goldman, suggesting that a rollover would decrease inventories too sharply.

goldmanbalances1

The irony, however, is that such market conditions, with prices reaching the $65 level, would stimulate even more non-OPEC supply, a scenario that could bring about a weaker-than-expected market in 2018. Whatever the case, OPEC’s conundrums are now the consequence of its own making, for failing to let the free market set the price.

 

ADD A COMMENT