The members of OPEC (Organization of the Petroleum Exporting Countries) continue to insist that their efforts to reduce global supplies of crude are progressing as expected. This was being done in an attempt to provide support for a higher price structure. Analysts in the industry are reporting a near 90% compliance, to the recent output cut. Although their claims of dwindling global oil supplies remain a bit exaggerated.
The cartel was assisted by the fact that discoveries of gas and oil fields were at a 60 year low last year. This was a result of the near collapse in new exploration and development of energy resources, when new investment was no longer practical for the industry.
Total world output of oil was in excess of 95 million barrels a day at the end of last year. OPEC only controls about 40% of that production. Their declining share is due to the discovery of more oil around the globe and in addition to new extraction technology. However, they do control enough of the trade to have a major influence on prices.
Last December, the 14 member oil cartel was able to announce an agreement that would share an output cut of 1.2 million barrels a day. The deal called for an overall daily ceiling of 32.5 million barrels from OPEC countries.
The problem from the beginning, was that a far larger reduction of 1.37 million barrels would be necessary, to really meet the production cap.
Regardless of that particular issue, crude prices surged near 9% after the announcement by OPEC, that a reduction agreement had actually been reached. Under the deal, most of the countries in OPEC it was said,would reduce output some 4.6%.
In order to hammer out an understanding, a number of nations within the cartel, would be allowed more leeway given their individual circumstances.
Since Libya was bogged down in a sectarian civil war, the country would be excused from any limits. The same went for Nigeria, which was in the midst of fighting a virulent insurgency.
Iran also insisted, that it be allowed to return to its normal range of production of 3.8 million barrels daily. This was the average of output that existed, before the imposition of international sanctions. At the end of 2016, this meant an additional 90,000 barrels of daily production.
Although Iraq agreed to abide by the deal in principle, the leadership there has indicated that output will be increased, after the present deal lapses in June. Iraq is fighting a protracted war against the Islamic State, in the northern areas of the country. There will be a hefty bill due for reconstruction, once the war finally winds down.
Finally, Indonesia decided to suspend its membership in OPEC. Their determination was made on the basis, that the cuts being demanded from individual nations was far too high.
For the first time in 15 years, OPEC was also able to get producers outside the cartel, to participate in the effort to lower global crude production. At 558,000 barrels a day, it would end up being the largest reduction ever offered by non-OPEC producers.
Together OPEC and those oil producers willing to participate in an output cut, control some 60% of the total global supply.
News of the non-OPEC agreement, sent crude prices surging another 4 % to 5%. Prices for a barrel of oil in the United States listed as West Texas Intermediate, was soon selling for over $53.00 USD (United States dollars). Brent an international priced oil, was now priced at $56.00 USD a barrel.
The Russians agreed to reduce their exports by some 300,000 barrels. Their participation was vital. Production of crude in Russia had reached a 30 year high last November, at 11.2 million barrels and was due to increase another 80,000 barrels in 2017.
The rest of the output was made by Azerbaijan at 35,000 barrels, Kazakhstan at 20,000 and Oman by 40,000.
Mexico was also willing to contribute an additional 100,000 barrels, but their production cut like Azerbaijan’s was likely to occur anyway, due to a natural decline.
Saudi Arabia and the other members of OPEC were hopeful that nearly two months into the output cuts,world prices for crude would now exceed $60.00 USD. Instead, the price level for oil is almost exactly where it as at the end of 2016.
Part of the problem is there are a number of major oil producers, that are unable or unwilling to participate in any output reduction. In countries where energy resources are owned by private companies, such an agreement could not be enforced by a national government. The United States and Canada, are the prime examples of this.
Unfortunately for OPEC members, the price for crude is high enough to encourage increased oil production, for those countries that remain outside the agreement. If prices would increase further, this problem would only be magnified.
The low level of long term investment in the oil industry during the years of 2014 to 2016, will hamper the ability of some nations to increase output quickly, but this is not the case everywhere.
This is particularly the situation in the United States. Since this past summer, 25 rigs a month are coming back on line. American production of shale oil is starting to rise once again and is likely to continue.
Unlike two years ago when prices were plummeting, thus forcing many smaller American producers into bankruptcy, the cost of extraction is far lower today. A consolidation in the industry and increasing efficiency, has decreased the cost of production substantially.
The break even point in oil production for many smaller firms, was as high as $70.00 USD, just a few years ago. Among those companies still in business, costs have been reduced by 30% to 50%. If the industry as a whole, can sustain oil prices at levels below the present market price, output is going to continue to climb.
Increasing production in the United States and elsewhere, is beginning to negate a portion of the OPEC and non-OPEC cut in output.
In the second week of February American crude oil inventories rose another 9.5 million barrels, nearly three times more than had been expected. It was the 6th consecutive week of rising supplies. Not including the Strategic Petroleum Reserve, it brings the total amount of oil in storage to 518 million barrels, a new all time record.
These huge oil stocks coincided with a drop in United States crude imports, of 1.34 million barrels a day. This reduced American demand, allows the glut of crude to continue to build elsewhere.
Gasoline inventories climbed as well by some 2.8 million barrels, bringing the total American supply to 259 million barrels. Total inventories of gasoline, were up 10% since the end of 2016.
Another element depressing global oil prices is the United States dollar. The currency is near a 14 year high. Since much of the world’s oil is factored in American dollars, prices will be lower when the valuation of the currency is higher.
Now that the OPEC production cap is in place, the question arises how effective is it? In the past, there has been a tendency for OPEC member nations, to sell more oil than they are are entitled to by an output agreement. There is a strong incentive to sell more oil at a higher price, made possible by an international reduction understanding.
The best way to test the effectiveness of an agreement to reduce crude exports, is to count the number of tankers leaving oil terminals of individual nations. However, if the oil is being sold through a pipeline, it is far more difficult to monitor the level being sold. International agencies and OPEC officials, are often forced to trust the information relayed to them by that respective country.
According to the IEA (International Energy Agency), global oil supplies fell by 1.5 million barrels a day last month. OPEC has calculated an even smaller daily reduction, of just 1.29 million barrels. This works out to be, an overall decline of just a little more than 1%.
The January production by OPEC of 32.13 million barrels is still ensuring that world supplies are still exceeding global demand. The total world output remains at 95.89 million barrels, while demand is close to 94.84 million barrels.
To make matters worse for OPEC, the developed world’s commercial oil stocks are still 299 million barrels above the five year average. As one can clearly see, the glut in crude is ongoing and inventories continue to rise.
As the primary swing producer, Saudi Arabia did reduce their output by almost 5% last month when compared to December. The Saudis claim that their crude production shrank by 717,600 barrels daily in January. This brought their total output down to 9.748 million barrels a day. If true, this was the largest cut in output in 8 years.
Yet, the price of oil last month was near 21% higher, than before last September, when it was announced there would be production cuts. The actual 5% reduction in crude output, has resulted in a more than 20% increase in global prices. It therefore stands to reason, that the incentive to discuss further reductions in crude production by the kingdom, is enormous.
Russia last year increased crude production by some 4% from August through November. The promise to cut 300,000 barrels a day never materialized. There was a reduction of 30,000 barrels in January from December, but total output is still far higher now than it was last summer.
Why the deception? At the present price level, both Russia and Saudi Arabia will still need to borrow money to balance their national budgets. However, they are no longer facing a fiscal crisis, nor will they have to devalue their currencies to remain solvent.
They can now afford to wait, for prices to gradually climb back to more traditional levels. These two countries will need crude prices to be closer to $70.00 USD, to regain a sounder financial footing.
Nations like Iran and Iraq in contrast, can already pay most of their governmental expenses at current prices.
The real unknown variable is how much more will production in the United States increase? American crude output has increased by 280,000 barrels, since the end of November. Total output is up 6.5% since the middle of 2016, back to 8.98 million barrels a day. Crude production is now at its highest level since April of last year.
United States shale production is expected to rise next month to 4.87 million barrels daily. This is the highest rate since last May. If the shale producers attempt to escalate their extraction of oil, closer to or even surpassing levels in 2015, it will flood the energy market with far more crude than can be easily absorbed.
It will then lead to another round of price cuts, that will mirror the near collapse that occurred in February of 2016. Crude in the United States hit a low of $26.05 USD a barrel that month, a 13 year low.
This will be a repeat of the oil cycle that took place from 2014 to 2016. As prices drop other oil exporters may well ramp up production again, to maintain the total income they derive from crude sales. This will lead to smaller companies in the United States, to begin to scale back production and the cycle will repeat itself.
Up to this point,oil investors have bought into the story of quotas and lower production created by the agreement reached by OPEC last year. As the year progresses, they will continue to notice the overabundance of crude being sold on world markets. These individuals will then begin to question the veracity of whether there has been a sufficient reduction in output, to justify the present 20% premium that is being paid for crude.
If further productions cuts are not put in place by OPEC later this spring, it will be difficult to maintain a price level for crude above $50.00 USD. The cost of oil cannot stay at this level, when producers are finding it increasingly difficult to find sufficient storage space for their product. Under these conditions, oil markets are likely to remain unbalanced in 2017.