OPEC cuts may continue, but US dictates market direction

May 19
17:23 2017

Shishir Asthana

Moneycontrol Research

Oil markets are interestingly poised ahead of a May 25 meeting of the oil cartel, OPEC. The consensus among OPEC-watchers is that the organisation is likely to extend its production cuts.

In November, OPEC members agreed on a production cut of 1.2 million barrels per day. This cut was supported by other non-OPEC producers led by Russia who cut production by another 600,000 barrels a day.

However, the 1.8-million barrel per day cut has not solved its dual purpose of higher oil prices and lower inventories. Though there is no authentic source of getting oil inventory data, analysts say that crude oil floating inventory is between 800 million to 1 billion barrel.

The price reaction to the November cut is likely to nudge OPEC to continue with its strategy. A Bloomberg poll of oil analysts suggests that 24 of the 25 analysts expect the cuts to continue. The largest OPEC member Saudi Arabia and non-OPEC member Russia have agreed to keep production at present levels, which has found support from some other countries who are participating in the cut.

However, over the last few years, the impact of OPEC on the oil market has come down. Its actions do not fetch the kind of responses they used to earlier. The US, a non-OPEC member, is now dictating the direction of the market.

The US, from being one of the biggest importers of oil is now an exporter. In fact its oil export is touching new records. At the going rate, exports from the US are likely to average 1 million barrels a day in May which is expected to surpass the average of 1.2 million barrels last seen in February 2017. A Reuters report says that nearly 10 million barrels of US oil is headed towards Asia. US oil production has increased by 10 percent to 9.3 million barrels per day since mid-2016.

The rebound in oil prices from their lows in February 2016 of around $ 26 a barrel led to a pickup in activity in the US. The bear market was a learning experience for the shale oil sector in the US where companies brought their cost of operation substantially lower.

Reports say that the cost to drill for shale has fallen by one-third in the last two years. Breakeven level in the sector is now in the range of $ 43-45 a barrel. With new technology, productivity of existing wells has also doubled since 2014.

As a result of these factors, the US oil rig count has doubled in one year, registering the strongest recovery in the US in the last 30 years. This is reflected in a near-record level of production. Analysts estimate that every dollar increase in the oil price between $ 45 and $ 55 a barrel results in an additional 1.2 billion barrels that become economical to produce.

The fear now is that US production may neutralise the effect of every barrel of oil that is cut by OPEC and other countries. Further, other OPEC nations, which did not participate in the previous cut, like Nigeria and Libya, will be adding more oil in the market and would continue to do so. Data released on Thursday shows that even Saudi Arabia has increased sales in the market by 275,000 barrels a day.

The current oil price movement suggests that a production cut would most likely continue, the only contentious part is the time frame. Reports suggests that a time line of 6-9 months is likely to be agreed upon. This however, would not be enough to keep oil prices buoyant given that the US supply taps are open.

If the cuts are not adhered to or the quantum reduced, prices can see a sharp drop. The best case scenario for the oil market seems to be a flat outlook for the sector.

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