Commodity Weekly: A Fracturing OPEC Sends Prices Lower

This opinion piece presents the opinions of the author.
It does not necessarily reflect the views of Rigzone.

Few positive signals for oil prices exist in the market at the moment. Following the Energy Information Agency’s (EIA) Wednesday report of surprise builds to U.S. stocks of oil and gasoline, market confidence was shaken. Off the newsflow, the front-month WTI contract fell 5 percent, while Brent was down 4 percent on the day.

 

Delia Morris

Oil prices Thursday stayed relatively flat – with WTI settling on the NYMEX down 8 cents at $45.64 per barrel. The Brent front-month contract settled down .4 percent at $47.87 per barrel. Intraday trading saw prices plumb lows not seen since early May, but pared losses by the end of the day – most likely due to short-covering.

The main reason for the loss of market confidence is increased doubt around the efficacy of an extension to production cuts by the Organization of the Petroleum Exporting Countries (OPEC) and non-OPEC to actually lend price support.

The dominant theory to date had been that the May 25 agreement among OPEC and major non-OPEC producers would help bring global oil markets back into balance. The agreement hoped to extend a commitment to cut output by 1.8 million barrels per day into March 2018. 

An upsurge in U.S. crude production – estimated by the EIA to grow from current levels of about 9.3 million barrels per day to 10 million barrels per day in 2018 – has been viewed as the greatest countervailing force that would slowdown the market’s approach toward equilibrium.

A mitigating factor, however, was the fact that U.S. oil inventories had been falling steadily over the previous weeks – due primarily to record levels of crude exports and refinery inputs.

With the summer driving season upon us, many in the market held the view that gasoline demand would return to robust levels. That notion was looking less certain with Wednesday’s EIA data showing that over the last 4-week period, motor gasoline consumption was down .7 percent over the previous year. Total U.S. products supplied were down 1.2 percent versus the same time in 2016, according to the EIA.

Another drag on oil prices has been the release of data showing that OPEC production for the month of May had risen by 270,000 barrels per day over April to 32.12 million barrels per day. The increase was largely a result of stepped up production from Libya and Nigeria, countries that are currently exempted from the coordinated output cut. Iraq also showed a boost to its May production of 70,000 barrels per day.

Although it’s open to debate as to the real drivers of the diplomatic row between Saudi Arabia (plus a handful of its Gulf neighbors and Egypt) and Qatar, it is clear that the rapid escalation of tensions, which began Sunday evening, failed to create a sustainable spike in oil prices.

Instead, the markets took this as a signal that waning OPEC cohesiveness and growing antagonism among member countries posed a significant barrier to the cartel’s ability to stabilize global prices.

Accusations were thrown at Qatar for cozying up too much to Saudi arch geopolitical rival Iran, and for also cow towing to Shiite militants in Northern Iraq and Syria by purportedly paying millions of dollars to free a group of Qatari falcon hunters held in captivity.

Might the ratcheting up of tensions been an attempt to achieve a knock-on effect of lifting the geopolitical risk premium on a barrel of crude? Possibly. What we have witnessed over the last year is that OPEC rhetoric and headline risk have had more impact on oil prices than the actual implementation of cuts – even with historically above-average adherence levels.

Truth be told, what the market is reacting to are the fundamentals, which continue to show that global oil supply remains above the historical 5-year average – the stated aim of the OPEC/non-OPEC production pullback.

A further fractured OPEC – one that has already seen its influence over global oil markets significantly reduced over the past few years – will likely work to increase global supply.

Members would be more inclined to break quota and strike out on their own to gain or maintain market share. At the same time, crude off-takers will look to diversify supply away from OPEC due to its unreliability, potentially to the benefit of other large producers, such as Russia and the United States.

Delia Morris has worked in the international upstream oil & gas industry for over 13 years. Please contact Delia at delia.morris@gmail.com.