Orlando's Outlook: Oil policy reversal

06-22-2018

Bottom line OPEC announced this morning it will increase oil production by one million barrels per day (BPD) starting in the second half of 2018, reversing the 1.8 million BPD production cut it successfully orchestrated 18 months ago. At today’s meeting in Vienna, officials from the 14 nations which comprise the Organization of the Petroleum Exporting Countries (OPEC), along with 13 non-OPEC countries including Russia, indicated they have reversed policy in an effort to help offset some 2 million BPD in collective at-risk production from Venezuela, Iran, Libya and Nigeria, in order to keep the global oil market stable.

Crude oil prices as measured by West Texas Intermediate (WTI) soared 74% over the past year, from a trough of $42 per barrel in June 2017 to its recent peak of $73 last month, as OPEC’s production cuts helped bring global supply and demand back into balance. But crude slumped 13% in the past month to $64 on Monday, as investors feared the meeting would result in a larger jump in production—perhaps to as high as 1.5 million BPD. However, because several OPEC members are unable to increase their production, today’s effective increase amounts to only about 600,000 to 700,000 BDP. That sparked a sigh-of-relief rally, as WTI prices are up 8% this week to $69.

Production cuts have worked At the beginning of 2017, the OPEC and non-OPEC oil-producing nations agreed to a joint production cut of 1.8 million BPD (about 1.8% of global oil supply), which was subsequently extended through year-end 2018. It was OPEC’s first coordinated joint reduction in crude-oil production in eight years, and it sharply reduced the global oversupply of oil. Their stated goal was to reduce storage quantities back to 5-year average levels. Before this accord was put into place, OECD oil stocks were a bloated 348 million barrels above the 5-year average, but that overage has since shrunk to 20 million barrels below the five-year average.

Russian motivation has waned At a 30-year high of 11 million BPD, Russia remains the largest crude-oil producer in the world. Russian President Vladimir Putin successfully won re-election for another 6-year term in March 2018, as higher energy prices and a stronger oil-centric economy put Russian voters in a better frame of mind when they went to the polls. Now Russia wants to reverse its own pledged production cuts of 300,000 BPD, and proposed at today’s meeting that OPEC production overall should rise by 1.5 million BPD.

Aramco IPO delayed again At about 10.2 million BPD, Saudi Arabia is the world’s third-largest crude oil producer and the largest within OPEC. It cut its own production by about 900,000 BPD from 2016’s peak production levels to help engineer a nearly 4-year high in oil prices of $74 in May. But the plans to execute an initial public offering (IPO) in its national oil company (Saudi Aramco) has been pushed back to 2019, so their immediate need for higher oil prices has subsided.

Saudis to stabilize market With WTI prices sharply higher and the global supply glut all but eliminated, the Saudis shifted gears and proposed boosting OPEC production by 1 million BPD, to help offset the potential shortfall of about 2 million BPD from four key OPEC producers:

  • Venezuela—an ongoing economic crisis has led to a cut of about 700,000 BPD
  • Iran—the return of U.S. economic sanctions on OPEC’s second-largest producer related to the nuclear deal in 2015 could force 500,000 BPD to trickle slowly through the black market
  • Libya—rebel attacks on port facilities have cut crude output in half, to about 500,000 BDP
  • Nigeria—militants in the Niger Delta have vandalized pipelines and stolen crude oil, reducing crude oil output by about 250,000 BPD

U.S. is swing producer The U.S. is now the world’s second-largest crude oil producer with about 10.7 million BPD, as fracking operators have become much more efficient, with profitability break-even levels at about $50 per barrel. Because the U.S. is not part of the Saudi/Russian OPEC agreement, U.S. frackers can pump to their hearts content, which should keep prices from soaring back above $100 per barrel. In fact, the demand for exported U.S. crude oil has helped to reduce our balance of trade deficit over the past few months.

Strong dollar could hurt crude prices The dollar fell 21% from 1.03 to 1.26 versus the euro over a 13-month period through February 2018, coinciding with the powerful 74% rally in WTI. But over the past four months, the dollar has rallied nearly 9% back to 1.16. We’ll be watching to see if this week’s 9% rally in crude is sustainable as the direction of the dollar and its relation to oil prices tends to be inverse.

Quid pro quo? President Trump has been tweeting recently that he thinks gas prices are too high in the U.S., and that OPEC should boost production to drive WTI prices lower. He then surprisingly proposed (unsuccessfully) to the G-7 that Russia be added back into that group of nations. Russian President Putin then proposed (unsuccessfully) this week in Vienna that OPEC production should be boosted by 1.5 million BPD.

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