Can An OPEC Production Cut Extension Push Oil Prices To $60?

It now seems quite likely that OPEC will agree to an extension of November’s production cut agreement at their May meeting. The question facing analysts and market watchers is how much a cut extension will impact the market going forward, and whether it will deliver the boost in oil prices that OPEC is hoping for.

In November, the agreement was a boon to the oil price, sending WTI north of $50, only for oil prices to fall a few months later. The impact of the deal, which was publicized for months beforehand and enjoyed blanket coverage from all major market media outlets, was significant but temporary. Inventory reports in February caused the oil price to crash back down, and apart from a brief swing upwards after U.S. missile strikes in Syria, an event which had analysts crowing over the return of the risk premium, oil prices have slumbered near $50, far below where OPEC needs them to be.

Undoubtedly, OPEC is hoping an extension of cuts will have a more lasting effect, delivering true stability to markets and lifting oil prices up to $60. The level several OPEC members have indicated they want oil prices to rest over the long-term, in order to balance their budgets. But a string of bearish signs have pushed the oil price below $50, and barring another bout of “geopolitical risk,” it seems only significant changes in fundamentals will deliver the boost OPEC needs.

The impact of the first round of cuts was blunted in part due to the ramp-up in oil production during the fourth quarter of 2016. Huge inventories were reported in the U.S. early in 2017, though there were declines in OECD inventories according to the IEA, evidence that the OPEC and non-OPEC cuts totaling 1.8 million bpd were having some effect, despite low compliance from non-OPEC states.

American oil inventories were expected to fall, boosting price in the short-term. Instead, unexpectedly high gasoline inventories pushed the price to its lowest point in weeks in mid-April, despite simultaneous drops in the crude supply. The decline of about 1 million barrels was less than analysts predicted.

American inventories are falling, which bode well for a price recovery if OPEC does decide to extend cuts. Yet the effect may not be immediate enough for OPEC to declare victory in June, as rising production in the fourth quarter of 2016 in OPEC and outside of OPEC in early 2017 basically obviated the cumulative effect of the cuts.

Nevertheless, plenty of analysts see bullish conditions ahead and a tighter market. Goldman Sachs and CitiGroup, among others, feel that prices will recover near $60. Goldman feels that recent declines are due to short-range factors, as fundamentals slowly shift towards tighter supply. The IEA, which has been warning of a much tighter supply situation in the years ahead as investment fails to keep up with demand, feels that inventory declines are likely in the summer despite demand falling for a second straight year. If inventories post big enough declines, the continued absence of 1.5 million bpd taken off the market early in the year could finally have the desired effect.

The IEA also predicts U.S. oil production growing by 680,000 bpd by the end of the year, an upgrade to initial forecasts.

Goldman’s feeling that recent drops in oil price are from short-term, speculative factors should give investors and analysts cause for optimism. The steep drop last week came on the back of a higher-than-expected rig count report and doubts over Russia’s possible compliance with further OPEC cuts. These could be interpreted as the emotional response of the markets, rather than a sure sign of shifting fundamentals. Five rigs were added in the most recent report, the lowest increase since February, and a possible sign that the boom in U.S. shale could be slackening.

Like the week-long boost after the U.S. missile strike in Syria, the sudden dip in prices last week could be offset once inventory draws deepen. If OPEC succeeds in lengthening, or even deepening cuts, and pulls Russia on board, there’s a chance that the IEA and Goldman’s prediction of a stabilizing oil market and a closer balance between supply and demand by the late-summer 2017 could come true.

But there’s plenty of skepticism out there. Inventory draws will have to be deep, and compliance among OPEC and non-OPEC members strong, for the anticipated increase in U.S. production to be successfully offset. – Gregory Brew

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