Prices highest since mid-2015
Brent is holding at two-year highs, with trading above $60 per barrel continuing for a second day. Both WTI and Brent did not show any significant movement in the day, ending up 0.41% and 0.86%, respectively. The price changes themselves are less significant than that the gains of Friday were not erased.
Oil prices are being buoyed on reports that the biggest question facing oil traders will be answered.
After the OPEC production cut was announced in late 2016, which threw a much welcomed lifeline to desperate U.S. producers, one of the main problems with the cut has been predicting its end. In March OPEC extended the cuts. While a temporary cut in output would help reduce global inventories, it seems unlikely that oil prices will remain in the $50s and $60s after the cut ends.
In theory, once production returned to approximately pre-cut levels, prices would return to pre-cut levels as well. This possibility has loomed over the industry. OPEC temporarily relieved the problem when it extended the cuts, pushing the expiration back to early 2018. It now appears that OPEC will extend cuts again, allowing the period of reduced supply to continue.
Saudi, Russian leaders express support for cut extension
Saudi Arabia’s Crown Prince Mohammed bin Salman’s told Bloomberg “of course” he wants to extend the cuts. “We need to continue stabilizing the market,” the prince said. Such explicit support of extending the production cuts from the most powerful man in OPEC’s largest producer significantly increases the possibility that the cuts will be extended beyond March 2018, and have encouraged oil traders.
Vladimir Putin has also expressed support for extending the agreement, meaning the largest oil producer in the world will likely continue to limit output as well.
The final decision regarding the OPEC cut will be made at the group’s meeting in November. OPEC head Mohammad Barkindo told Reuters “OPEC welcomes the clear guidance from the crown prince of Saudi Arabia on the need to achieve stable oil markets and sustain it beyond the first quarter of 2018. Together with the statement expressed by President Putin this clears the fog on the way to Vienna on Nov. 30.”
Global inventories of crude oil have fallen significantly since the OPEC cut began, but remain above five-year averages. Overall, surplus inventories beyond the five-year average are about half of last year’s levels, meaning the cuts have seen success, but not nearly as quickly as expected.
How can OPEC end cuts?
The next job for OPEC will be determining how to end the cuts, or if they should be ended at all. A “hard landing” from the reduced production would almost certainly mean a price shock, which would make the cuts useless. A gradual increase in production would help, but the extra supply would weigh on oil prices. In addition, OPEC controls only part of the oil market, and other producers have been taking advantage of the increase in prices.
U.S. production erased 47% of OPEC cut
According to the EIA, the major shale basins in the U.S. have added a combined 850 MBOPD in 2017, meaning the U.S. has singlehandedly wiped out about 47% of the volume taken off the market by the cut. Production increases from Libya and Nigeria have added another 570 MBOPD, or 32% of the volume cut by OPEC. In short, growth from other producers means there is less room for OPEC to bring production back onto the market.
If the group’s members wish to keep oil prices high, it may be necessary to reduce production indefinitely, or at least only partially increase production when cuts run out.
