ETF Securities Research Blog

Oil prices fall as OPEC has no positive surprise up its sleeve.

OPEC and its non-OPEC partners have agreed to freeze production at current levels for another nine months. Current production levels are approximately 1.8mn barrels per day lower than they were in October 2016, if the output figures are to be believed. The market has been led to believe that this would be the likely outcome from the meeting after the major players had already announced that a nine-month extension was palatable. With the market conditioned to expect surprises emerging from the “smoke and mirrors” format of OPEC meetings, the result of the current meeting has been an anti-climax.

The Saudi-Arabian led cartel has sought to bolster prices after the price collapse that emerged when its 2014 experiment failed and crippled many OPEC member economies. Saudi Arabia wants to sell part of its state oil company to boost its financial coffers, which is the chief reason why it wants oil prices to trade above US$50/bbl. Other members have followed and sacrificed production as higher prices have helped turn revenues around. However, revenues are unlikely to reach levels these countries are accustomed to.

opec revenue

Oil continues to trade in a tight range with the upper bound at US$55/bbl. As we argued in “OPEC’s choices: double down or do nothing”, a deeper cut would be need to shock the market to drive prices higher. With US, Canadian and Brazilian production continuing to grow and global demand remaining soft, global oil inventories will remain elevated. OPEC’s target of bringing down the level of OECD oil inventories to its 5-year average will continuingly be undermined by the growth in US shale oil.

Driven by the price war that OPEC initiated in 2014, US shale oil players are leaner than they have ever been and can make profit at considerably lower prices than in 2014.

shale breakeven

At current prices we expect US production to grow. Rigs are considerably more efficient than they used to be. The US is close to producing record amounts of oil with almost half the number of rigs as there were at the peak in 2014. Persistent and nimble US producers are likely to continue to undermine the efforts of OPEC. In the absence of a deeper cut, we expect prices to continue to grind lower, possibly below US$50/bbl.

We expect OPEC compliance to its agreement to fade as has historically been the pattern. With Saudi Arabia having the most to lose from a collapse in the deal, we expect other members to free-ride on its efforts to keep a lid a production. As other members question what will happen after the Saudi Aramco IPO, we doubt the notion of ‘solidarity’ is as strong as being portrayed in front of the press. Although Russia, the largest non-OPEC member in the deal, claims to have been cutting more than is needed, it contradicts the data in the OPEC monthly reports.[1] As compliance comes under greater scrutiny, prices are likely to weaken. We continue to believe that oil will range trade between US$40-55/bbl.

rigs vs prod

[1] In OPEC’s November report, Russia was producing 10.59mb/d in October and in OPEC’s May report, Russia was producing 10.39mb/d in April. That only amounts to a 200k b/d cut, compared to the 300k b/d Russia signed up to for each month.
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