Oil Deal: Can OPEC Afford One?

I
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.

More in this category: « Deal, No Deal
Osama Rizvi

Independent economic analyst, Writer and Editor

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