[yt_dropcap type=”square” font=”” size=”14″ color=”#000″ background=”#fff” ] I [/yt_dropcap]n my last article I covered different prospects/facets that signaled towards the extension of an oil deal. Of late there are developments that not only serve as a testimony to the possibility of an extension but also its probable segue into the year 2018 (until March).
Recently Russia and Saudi Arabia, in order to give some support to the falling oil prices (that stood at a level before the Vienna deal), gave a joint statement declaring that they will do whatever they can to balance the oil markets and that the deal may be extended to March 2018. It remains to be seen that other OPEC and NOPEC producers agree with them or not but as the influence of both the countries in the first and latter camps is evident the oil prices surged by 3% on the very day of announcement. On the other hand the story remains the same: Rising oil production, ballooning inventories and rigs being added every week. So while market observers try to answer the question of whether there is a possibility of such an extension? The main question, however, is that: Whether they (Oil producers) can afford one?
Of course the producers in question are not the Shale, which are ramping up production and giving a tough time to OPEC, as a Bloomberg article said, by increasing their investment by 32% to $84 billion. Such a surge in outlays (51 percent in 2017) is quite surprising as the oil markets and companies still struggle to shed of the residual effects of the recent oil price crash (starting in 2014). The rig count is at historic highs so are the Cushing inventories, although there has been few withdraws. The US production has reached from 8 million barrel mid-2016 to 9.23 million in the month of April. (Also see EIA’s drilling productivity report). More crude is coming in, or is planned to, as the Sharara oil field in Libya starts oozing oil once again. Nigeria is expected to raise production as well. Many oil companies are back at the once deserted projects too.
Where does all this fit in with the production cuts? Nowhere. In fact, this can provide a serious offsetting effect, in case the deal is extended, and may falter the belief of the signatories even after the success of the extension. On the contrary, as the main thesis of the article purports, the OPEC producers cannot afford an extension of 9 months. The empirical evidence which one can gather very easily throughout these 6 months, glimpses of which are also given above, is enough to suggest that a further price hike, which will naturally and obviously follow in case of the deal, will make US Shale producers more daunting in their approach to take on more big projects also effecting the incumbent drilling activity. Permian basin, especially, is viable even at $30 per barrel.
But there are experts echoing bullishness in the years to come. Consider the analysis of Mr. Bill Strazzullo, who sees oil at $90 in few years. It should also be noted that this man predicted the recent oil price crash when there were no signs, not even a whiff, of such a crisis. IEA is also bullish as it sees a difference in supply and demand by 2022, that the demand will overcome supply given the recent cuts in E&P budgets. Goldman Sachs, has said to go long on oil, as the investment banks sees a tighter oil supply and inventory withdraws in next months. But the most feasible analysis is that of Goldman Sachs as the effect of an oil deal extension coupled along with the US summer driving season may tweak the oil markets in a positive sense.
But none of this related to fundamentals. That is to say supply and demand. The supply, if not from the Middle East, but from US is still adding up. The demand has all but shown a promising side with projections that countries like India and other Non-OECD countries may provide some suction force to take out the supply. The bullish outlook of IEA is hard to buy as the oil projects reduce the payback and lead time hence bringing the production at a faster rate to the markets than before. Also, as aforesaid, there are evidences that projects are coming back, oil companies have also posted profits recently. What is going to happen, if we are to take an educated guess, the oil prices will rise or remain stable in the third and fourth quarter of this year, provided that there are inventory withdraws and the OPEC and NOPEC producers remain loyal to the deal. But as it happened few months back when the inventories were increased by 8.4 million barrel and the prices crashed once again. And as happened few weeks back when the news of rising US production and come back of Libyan oil made the prices take a turn back at square one (Reality Check).
There is a specific pattern that a keen observer can trace out according to which oil markets tend to move these days:
Displacement——–Euphoria————Reality Check————Price Drop———-Stability.
When the oil producers meet on 25th of May, the markets would be in the first stage. After the euphoria has settled, the oil markets will get a reality check when the news of unyielding shale production will start to flow in. Libyan and Nigerian oil production may exacerbate the situation. The prices will drop (as they did twice-explained above). Then there will be a lull. The prices will stabilize at that point not going down further, as there will be deal in place, and prices not rallying up due to the sentimental/speculative effects of that deal. It is very hard for oil prices to cross the mark of $60, $65 is the maximum. At least for 2018.
Oil Markets Ignoring Realities
Brent oil touched $68 last week. WTI is already past $60 mark. Inventories are down by 20% nearing to the five year moving average of 420 million barrels. But all is not hunky-dory with the oil markets. There are some wildcards at play right now. Temporary factors, driving prices up. The markets and observers need not to lose sight of what are the potential risks to this upbeat and probably short-lived phase of recovery.
Last year we saw the Kurdish referendum which resulted in a price hike. However, we didn’t know that 2018 will have another big surprise (distressing one) in its stock: Unrests in Iran. Slogans like “Death to Khamenei” cannot be taken lightly. Nor the killings that have ensued as a result of these protests. Government has warned to deal with an “iron fist” in order to control the situation which only seems to get worse. This is one of the factors that are drawing oil prices up, representing the typical relationship between any unrest/disorder/conflict in Middle-East resulting into a higher oil price. But matters are not that simple. If these unrests can translate into a higher oil price, it can also cause Iran, in case tensions escalate, to leave the Vienna accord. This can be due to more sanctions slapped upon the regime in case they take any serious action against the protesters or due to general economic problems that might result, once again, if matters exacerbate.
Pipeline outages also helped to provide some buoyancy to oil prices. Disruptions in Forties Pipeline, one of the most important in the world, gave prices a boost when the company announced that it can take a longer time to repair the hairline crack that appeared in December, 2017. However it is fully operational as of now.
The recent meeting wherein members of Vienna accord decided to extend their deal for the full 2018 year was another cause of merriment for the oil markets. But that caveat according to which the members will meet again in June to review the situation can be taken as a wicket-gate for the ones who want an exit. Russia has already signaled to take about an exit strategy. The oil executives in Russia are not happy to see the growing U.S. shale production and market share.Kingdom of Saudi Arabia has its own reasons. They have an IPO to take care of hence; they are trying to keep all these oil producers together. But the question might be asked: For how long? It is their company (Aramco) and their IPO. Not every country in the region has a plan to wean itself off oil.
What has become a necessary part of the narrative whenever discussion the future of oil, in terms of prices or usage, is of-course, United States of America. U.S’ shale production has risen from 8 million barrels in 2016 to 9.78 million barrels per day (latest). The estimates for future rise in US production are promising. What is also important, but obvious, to mention here about the vicious cycle that higher oil prices trigger. The solution to which is only a stronger demand.
Even though oil prices are at post-crisis high it doesn’t mean that the trend will continue. Sustainability is the most important and decisive factor. Geopolitical risk premiums are temporary. So are the pipeline outages (if in case there are any in future). Time and again, we have to remind ourselves of not getting carried away by these ephemeral rallies. We should look for something sustainable, permanent, and fundamental. Until or unless we find it, the search for higher oil prices should continue.
Shale growth, Geopolitical tensions and Re-balancing
It has been a wild ride for oil prices. November 4th, 2017, prime minister of Lebanon Mr. Hariri resigns, at night missiles from rebel occupied Yemen can be seen hurtling across the sky of Kingdom of Saudi Arabia. What begins next has been widely covered by all the major media outlets.
Crude Oil Bearishness Is Here To Stay
Despite seven weeks of inventory withdrawals, the global oil market has failed to translate this effect into a sustainable and significant oil price increase. Doubts remain. As reported, OPEC production has edged up. The compliance rate among OPEC and NOPEC members of the Vienna deal, extended to March 2018, has fallen. US production has added more barrels to global production.
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