OPEC Extends Cuts, Oil Prices Fall: What It Means

Posted in The Petroleum Truth Report on May 29, 2017

OPEC extended oil production cuts last week and oil prices plunged.

OPEC’s goal was to keep a floor under current prices but the market expected the cartel to move prices higher through inventory reduction. OPEC was satisfied with greater revenues from higher prices compared to a year ago, but the market wanted deeper production cuts. OPEC takes the long view but the market is concerned with the near term. OPEC extended the cuts and the market reacted with lower prices.

Analysts have created the unfounded but widely accepted belief that OPEC has a strategy that involves a price war with U.S. tight oil producers and a play for greater market share. The cartel’s inaction before last November’s production cuts reflected an unwillingness to repeat the mistake of cutting 14 million barrels per day between 1980 and 1985 with little effect on world over-supply and financial damage for OPEC members.

OPEC’s  members have disparate needs and interests. They are not unified behind any mission statement or over-arching principles except to maximize revenues and minimize losses. IEA calculated that recent production cuts earned the cartel an additional $75 million per day year-over-year in the first quarter of 2017. It also was a gift to competitors so the idea of making deeper cuts had no cost benefit.

Last week’s price plunge was the third time in 2017 that prices have adjusted downward toward the $45 per barrel level suggested by market fundamentals (Figure 1).

Figure 1. Third Deflation of the OPEC Expectation Premium in 2017. Source: EIA, Bloomberg and Labyrinth Consulting Services, Inc.

At first, OPEC did nothing after oil prices collapsed in 2014. When prices fell to $26 per barrel in early 2016, OPEC floated the idea of a production freeze and that established a floor from which prices increased to more than $50 per barrel during the first half of the year (Figure 2).

Figure 2. Oil Markets Continue Testing $55 Ceiling & $45 Floor. Source: EIA, CBOE, Bloomberg and Labyrinth Consulting Services, Inc.

In June 2016, markets lost faith in OPEC’s resolve and prices fell from $51 to below $40 per barrel. OPEC then set another price floor by announcing tentative agreement on a production cut. When prices fell below $43 in November, another price floor was created when OPEC enacted production cuts.

The world price floor moved up almost 75% from $26 to $45 per barrel in just over a year. That looks like success to me. Production cuts were extended last week to reinforce the current $45 floor without helping the competition too much—not to meet market expectations of higher prices.

Oil traders understand this better than analysts and they began unwinding their long positions in February. Net long positions on WTI futures have fallen 25% since then but most of the sell-off has been since April 2017 (Figure 3).

Figure 3. Net Long Futures Positions Have Fallen 17% Since Mid-April 2017 and 25% Since March 2017. Source: CFTC, EIA and Labyrinth Consulting Services, Inc.

Reasons For Lower Prices

Many analysts proclaim that Brent prices will be near $65 by the end of the year. Although IEA and EIA production data suggests good OPEC compliance with the November agreement, global markets remain well supplied.  OPEC shipments to its biggest customers—the U.S. and China—are more than 10% higher than a year ago. Production cuts are not reflected in well-supplied markets nor are global inventories falling much.

Market concerns are valid that U.S. tight oil output may cancel OPEC production cuts. Despite frack crew shortages and limits to pressure pumping equipment, 2017 well completion rates appear strong in the Bakken, Eagle Ford and Permian basin plays (Figure 4).

Figure 4. Increased Tight Oil Well Completion in 2017. Source: EIA and Labyrinth Consulting Services, Inc.

OECD comparative inventory for April was approximately 300 million barrels above the 5-year average. The price vs. comparative inventory yield curve suggests that Brent is as much as $7 per barrel over-valued at $52 per barrel (Figure 5).  If recent withdrawal levels hold, it may take a year to reduce inventories to levels that support $65 Brent prices. On the other hand, EIA forecasts suggest relatively minor OECD inventory drawdowns through year-end and rising inventories in 2018.

Figure 5. Brent is ~ $7 over-valued at $52.31. Source: EIA STEO May 2017 and Labyrinth Consulting Services, Inc.

World production surpluses have been falling for the last year but EIA expects these to start increasing as early as May (Figure 6). Surpluses may persist through the middle of 2018 before decreasing again. Its forecast is for Brent prices to remain less than $60 per barrel through the end of 2018.

Figure 6. EIA Forecasts Production Surplus To Increase in the Second Half of 2017 Through the First Half of 2018. Source: EIA STEO May 2017 and Labyrinth Consulting Services, Inc.

Recent modeling by Macquarie Research supports this view and predicts sub-$60 Brent prices through the second quarter of 2019 (Figure 7).

Figure 7. Macquarie Forecasts Brent Prices Below $60 Through the Second Quarter of 2019. Source: Macquarie Research and Labyrinth Consulting Services, Inc.

Although OPEC cuts appear to be real, Macquarie sees U.S., Russia and Brazil production growth as bearish drivers on price. Maintaining OPEC cuts beyond the end of 2017 will be difficult and recent talk of selling half of U.S. strategic reserves potentially puts an additional 300 million barrels of oil on an already over-supplied market.

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10 comments on this entry


  1. How much oil is purchased at the wellhead to just put in storage and sell in the future at a profit? Oil futures are still in con tango but is flat taking away this incentive and possibly shutting in at least some wells.


  2. Ken,

    I don’t know the answer to your question about crude oil sales. WTI futures have been in rather steep backwardation since April.

    WTI-Futures-Have-Been-Backwardated-Since-April-2017

    All the best,

    Art


  3. Art always gives straight forward, easy to interpret, information on oil prices.
    Great work! thanks Art!


  4. Thanks, Don.

    Art


  5. The Australian public broadcaster belittles OPEC

    29/5/2017
    Australian ABC TV selectively quotes BP to match its own “no worries” narrative
    http://crudeoilpeak.info/australian-abc-tv-selectively-quotes-bp-to-match-its-own-no-worries-narrative


  6. Matt,

    That is an incredible narrative told on Australia TV and a great post refuting it.

    Here is a similar OPEC production graph that also includes Russia and Mexico. It shows levels are back to June 2015.

    OPEC-NOPEC-Crude-Oil-Production-At-Lowest-Level-Since-June-2015

    All the best,

    Art


  7. Art

    Thanks again for your very informative research
    Obviously the short term the world is well supplied in oil.
    From a hindsight view this is because projects sanctioned between 2010 and 2014 are coming into production from 2015 until 2018 and they have provided a little to much oil to soon.
    If you are to believe the 6 o’clock news readers going forward Shale will be able to fill all the missing gaps from the large long term projects such as Mad Dog II etc.
    From my reading US shale oil produces about 4-5MMbpd with a weighted average decline of say 50%. With current drilling that means shale must add 2MMbpd/year just to stay where current production is before any growth is achieved
    Also from my reading conventional crude is producing about 70MMbpd with a decline rate of 6% meaning need to add 4MMbpd/year.
    If you look from 2014 onwards less than 10 major new oil developments have been sanctioned. Historically over this time there would have been closer to 30 developments just to keep production steady and nearer 40 to have production increase.
    I note Matt refers to the BP releases which state BP have developed 7 major new projects over the last year – what they don’t state is all except one are gas and the only oil project only will add 100,000 bpd after 2020
    To conclude my observation – yes we are oversupplied for the next 18 months to 2 years but if we don’t invest in new projects come 2020 the joke from South Australia of what did we use before candles answer electric will become for the world what did we use before horses and carts – automobiles

    Looking forward to your next post

    regards

    John


  8. John,

    You are completely correct. I suggest that you read Matt’s post on Crude Oil Peak.

    All the best,

    Art


  9. Seems to me that “legacy oil” in US isn’t growing & “liquids” are in oversupply. Blending liquids and heavy oil is the new “intermediate” oils. I see reserve purchases where supposed “oil” reserves are selling for under $10/boe. That suggests to me a lot of it is liquids and nat gas being touted as “boe” when reporting in mmcfge might better reflect the nature of the crude actually in the ground.


  10. Terrell,

    Your observation is accurate. Even if we ignore NGLs, 70% of U.S. crude oil is > 35° API gravity and U.S. refineries are designed for 32.5° API oil.

    0-of-U.S.-Crude-Oil-30%C2%B0-API-and-70-35%C2%B0-API

    Recent Saudi statements that they are going to limit exports to the U.S. to draw down U.S. stocks are silly. Saudi oil is 30° API and refinery-ready. If we don’t have enough Saudi oil, we will have to import a similar grade from some other country because we don’t have it here.

    All the best,

    Art