By Cyril Widdershoven
Today’s OPEC report is a clear sign of a sustainable bear market, with the cartel’s oil production falling slightly in August, while its demand forecast for 2017-2018 rose.
OPEC produced 32.76 million bpd in August, which is 79,100 bpd less than in July. This drop in volume came from OPEC’s key producers cutting their production enough to mitigate increased volumes from Nigeria and Libya. The figures also show that members of the production cut deal have been largely successful in sustaining their target of 1.8 million bpd.
Crude oil stockpiles were still 195 million barrels above the five-year average in July, but market optimism is now growing that a downward trend in stocks will be clearly visible in the next couple of months. Saudi Arabia and Russia are already discussing a possible production cut extension beyond March 2018, which could be sufficient to remove pressure in the market, leading to a long-awaited price rally.
The majority of analysts have been questioning the current strategy of OPEC and Russia (supported by several smaller non-OPEC countries), as the effects on global crude stocks and prices have been minimal so far.
The recent resurgence of production in Libya and Nigeria, combined with an aggressive production strategy in Iran and Iraq, did not bode well for markets. At the same time, U.S. shale oil production made headlines, as the number of rigs increased week on week and production volumes continued to show a slight upward trend. However, the reality on the ground was different, as politics, security and technology began to constrain further production increases. Libya and Nigeria experienced a growing number of insurgencies that destabilized their oil infrastructure. Iran and Iraq have seen production increases as well, but sustainability is far from certain.
OPEC’s overall production future looks bleaker by the day, as insecurity and political instability appear to be growing substantially. Libya, Nigeria and Venezuela could face anything from a severe restraint in production capabilities to a total breakdown of their oil production systems before the end of the year. Falling production from these countries is not likely to be countered by other OPEC members, as they will instead reap the financial rewards of higher crude oil prices.
Meanwhile, shale production status looks increasingly wobbly. While overall production is still increasing, financial and technical challenges are starting to bite. Since January 2017, the average production volume per well has seen a severe decline. Most of this has been countered by new and additional drilling, but the costs of drilling these wells is increasing. For most shale oil producers, the end of 2017 could be a make or break period, as their current production hedge contracts are ending. Profit margins will go down if they’re not able to raise additional capital or keep to the current buffer mechanisms. The OPEC strategy, deemed a failure by many analysts, may finally be working. A Dutch proverb comes to mind when describing OPEC’s efforts: “I will struggle but I will conquer”.
When taking normal fundamentals, which, when all is said and done, are still the most important aspect of markets, a price rally is imminent. This rally may receive a real kickstart if the negative effects of the current Hurricane Season are mitigated by the positive effects of rebuilding efforts in Texas and Florida. OPEC’s own analysis is optimistic about the outcome, in stark contrast to a majority of U.S. oil analysts. Again, OPEC just has to wait and see; the proof is in the pudding.
If Saudi Arabia, Russia, and perhaps other GCC states are willing to continue their current production cut compliance, the future is bright. Additional support for a rally could even come from within OPEC, with a possible new crisis in Iraq brewing as the Kurdish Independence Referendum nears, and with Washington preparing strong action against Iran in the near future. Both issues could easily take out substantial amounts of crude oil the coming months. The Qatari issue, seen by most analysts as a non-OPEC related conflict, should also be factored in. The situation is reaching boiling point, and could easily result in negative effects for Gulf based oil and gas supply and production.
Supply is at risk and under pressure, while demand is still growing. OPEC’s reassessment of demand growth is consistent with current market developments. OPEC boosting oil demand in 2017 by 1.42 million bpd (an increase of 40,000 bpd). The oil cartel expects for 2018 demand to reach 98.1 million bpd, up 100,000 bpd in comparison to last month’s report.
The lights just turned green and the bulls are already on the streets. The coming days will decide where sentiment will go, as journalists and analysts battle to interpret the incoming data. Looking at how things stand however, OPEC leaders can go to their next meeting full of confidence, Saudi Crown Prince Mohammed Bin Salman, UAE’s Mohammed Bin Zayed and Russia’s Vladimir Putin now have to decide how far the rally should go—making sure that oil prices don’t go too high too quickly