Why OPEC Couldn’t Move Oil Prices Higher?

Concerns remain that OPEC-led production cuts will support a further rise in output from the United States, where producers can operate at much lower costs.

 

The latest OPEC meeting was uncharacteristically tranquil, with little of the eleventh hour infighting and arm-twisting that has been so prevalent in previous meetings. The cooperative spirit has allowed OPEC to roll over its production cuts for another nine months, as expected, a move that has to be described as a successful outcome.

Yet the oil markets are unimpressed, Oilprice.com has announced recently. Crude prices dropped on Thursday as it became apparent that a much more aggressive move – a lengthier extension or deeper supply cuts – was off the table. For OPEC, the price reaction is surely frustrating. Keeping so many oil producers on board with a plan that requires significant sacrifice has always been a monumental task, not least because many of the countries involved seriously distrust one another. More importantly, they are extending the cuts for another nine months, longer than anyone expected up until just a few weeks ago.

Goldman Sachs attributed the sharp drop in oil prices to three aspects of the OPEC deal: lack of deeper cuts; failure to impose production caps for Libya and Nigeria, which are exempt from the reductions; and the absence of "a clear exit strategy" beyond attempts to manage seasonal stockpile builds in the first quarter of 2018, Reuters reported on Friday.

Investor positioning and technical trading also played a roll in the acceleration in selling on Thursday, as oil prices fell through 50- and 200-day moving averages, the investment bank said.

Some analysts also attributed Thursday's plunge to a disconnect between investor sentiment and OPEC's intentions.

"The problem is that investors look at impact today, while OPEC focuses on reaching stability in the coming 6-9 months, so the long squeeze yesterday was overdone a bit," said Hans van Cleef, senior energy economist at ABN Amro.

Producers are confident that the plan will bring down crude oil stocks to their five-year average of 2.7 billion barrels, but oil investors had hoped for a last-minute agreement on more far-reaching action.

"The front of the curve declined the most, which at least for now implies that the market doesn't quite believe that a tightening and/or backwardation is really coming," Analysts at JBC Energy said.

Concerns remain that OPEC-led production cuts will support a further rise in output from the United States, where producers can operate at much lower costs.

Ann-Louise Hittle, vice president at energy consultancy Wood Mackenzie said the "decision in Vienna sends a signal of continued support for oil prices from OPEC which helps U.S. onshore drillers make plans" to further raise their production.

U.S. oil production has already risen by 10 percent since mid-2016 to over 9.3 million bpd, close to the output of top producers Russia and Saudi Arabia.

On Friday, oilfield services company Baker Hughes reported its weekly count of oil rigs operating in the United States jumped for a 19th straight week. It rose by 2 rigs to a total of 722, up from 316 at this time last year.

With U.S. output rising steadily and OPEC and its allies potentially ramping up production in 2018 to regain lost market share, many traders, including Goldman Sachs, already expect another price slump.

Other assessments pointed to the possibility of output cuts being extended into 2019 in order to bring down both crude oil and refined product stocks.

"Output controls will eventually be extended at least until the end of 2018, and more likely than not into 2019 ... At this pace, it will not be until at least the end of 2018, or indeed, 2019, when surplus inventories can be eliminated," said analysts at Deutsche Bank.

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