Ever since crude-oil prices entered uncharted territory, no clear way out has appeared.
Ever since crude-oil prices entered uncharted territory, no clear way out has appeared. Crude is finding it difficult to hold above $55 since US production rises sharply once prices touch that level. On the contrary, OPEC’s heavy reliance on income from exports of crude oil hurt their economies when prices drop to around $40-45. Hence, $45-55 seems to be the via media for prices of crude oil. OPEC and non-OPEC have talked about re-balancing the crude market. However, vested interests of some member countries seem to be a major headwind in re-balancing the demand-supply equation. Also, members are concerned about protecting their market shares in the context of a shale-oil boom in the US.
OPEC has extended its production-cut agreement to March 2018, as the earlier deal failed to achieve the desired results. Nevertheless, the deal does not seem to be working since all members have not been complying with it. Libya and Nigeria have been exempt from production cuts. As a result, their crude-oil production is rising steadily; Libya’s to one million b/d in July (from 847,000 in June) and Nigeria’s to 1.75 million b/d in July (from 1.71 million). Libya and Nigeria’s rising crude-oil output offset OPEC’s efforts to cut production. Recently, Nigeria agreed to either cap or cut output from 1.8 million b/d, once it stabilises at that level. Libya is still exempt. And, Saudi Arabia’s production increased in July.
Chart: OPEC crude-oil production
Iraq’s crude oil production declined to 4.47 million b/d in July, from 4.5 million the month prior. Recently however, its oil minister stated that the country aims at five million b/d by end-2017. Also, Ecuador said that it would not meet OPEC’s production cut as it needs to pump more oil to contain its fiscal deficit. It had agreed to cut production by 26,000 b/d, a small amount compared with OPEC’s pledge to cut 1.8 million b/d. This (bucking the trend), however, is significant due to the absence of unity among OPEC regarding production cuts. It could prompt other member countries to renege on their commitments.
OPEC's 78% June compliance with the deal slipped to a new low of 75% in July. The fear is that this compliance could slip further in coming months as lower-than-expected oil prices and slower-than-anticipated market rebalancing would discourage OPEC from cutting production. On the other hand, US crude-oil production has continued to rise. The EIA predicts that US production could rise to a record high of 9.9 million b/d in 2018. This re-inforces concerns of a global supply glut. Also, technological advances have reduced costs for US shale-oil producers. And, production by Brazil and Canada is increasing. So far, Russia has refrained from deeper production cuts. Latest data show global oil supply increased by 0.17 million b/d to 97.3 million b/d in July 2017. In Europe, stocks in the Amsterdam-Rotterdam-Antwerp region rose 6.9% from a year ago, to 43.9 million b/d.
Chart: US rig count vs crude-oil production
Source: OPEC monthly report
Nevertheless, a sharp decline in inventories in recent weeks could provide some relief to crude prices. The US rig count has fallen a fraction, but traders would need more data to conclude whether such a drop is sustainable. The most important factor that could change the short-term direction of crude price movement is sanctions on Venezuela’s crude-oil sector. The economic, political and security situation in Venezuela is likely to worsen due to the controversial policies of its president. Also, debt is high and the country is unlikely to make payments. The ongoing turmoil in the country has led to a decline in its crude oil production to 1.93 million b/d in July, from 1.95 million the month prior. And the controversial policies of its president have led to the US threatening to impose sanctions on the country’s oil sector. If that happens, crude oil prices might climb up sharply.
Overall, the global supply glut is weighing heavily on crude oil prices. Further, the lack of unity among OPEC to re-balance the market is keeping prices down. If the compliance rate falls further, the possibility of crude oil moving below $40 cannot be ruled out. The outlook for crude oil is both bearish and bleak.The writer is head of commodity research & advisory at AnandRathi Commodities