Oil Rises on Expectations for Production Cuts, Lower US Inventories

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The start of the trading year Tuesday showed that oil markets are still susceptible to headline risk, and will be volatile as a result. During the first and second quarters of 2017, focus will be on any indication that the Organization of the Petroleum Export Countries (OPEC) is actually adhering to a proposed cut of 1.2 million barrels per day.

Reports that OPEC members Kuwait and Oman had reduced production by 135,000 barrels per day and 45,000 barrels per day, respectively, helped to boost prices during intraday trading. Markets were looking for evidence to promote confidence that the six-month coordinated pullback in production, that commenced Jan. 1, was on course.

A strong U.S. dollar will continue to present future headwinds, however, to any gains in oil prices – even if there is a high level of compliance with output cuts among OPEC and non-OPEC participants. Off the back of stronger than expected U.S. manufacturing data, the dollar hit a 14-year high Tuesday, which capped prices on the day.

The front-month WTI contract settled up 1.8 percent Wednesday on the NYMEX at $53.26 per barrel, while the Brent front-month contract rose 1.8 percent on the ICE to $56.46 per barrel.

Due to the holiday week, the Energy Information Agency (EIA) will release its Weekly Petroleum Status Report Thursday, on a one-day delay. In Thursday’s EIA report, markets will be looking for a drawdown in inventories at Cushing, OK, which is the delivery hub for the U.S. benchmark, West Texas Intermediate (WTI). In 2016, storage levels at Cushing were at record levels.

Another data point to watch is the U.S. oil production figure which has been growing in recent weeks. U.S. output, which stood at about 8.8 million barrels per day for the week ending Dec. 23, 2016, is expected to increase into 2017 as shale players bring production onstream, commensurate with any uplift in prices.

There is some market speculation that because a portion of the Brent futures curve has moved from contango into backwardation, there will be little incentive for U.S. tight oil producers to lock in hedges for 2018, which would imply lower output going forward.

However, there is no question that over the more than two-year price downturn, U.S. shale producers have been able to reduce cost structures via operational efficiency gains and other factors. Breakevens in some of the core areas of the Eagle Ford, and other plays have been reduced from $60 per barrel to sub-$40 per barrel, according to some operators.

If WTI prices climb toward $55 per barrel during the first half of 2017 – as is expected if there is strong evidence that the coordinated output cuts are taking hold – there could be an opening of the spigots in the U.S. onshore space. With the short-cycle nature of shale developments, operators could potentially undercut the intentions of the coordinated cut, which is to remove approximately 2 percent of global production from the market.

As it stands, the U.S. is boosting exports of crude and products. Global oil flows are in the throes of change as well. U.S. refineries are also operating at high utilization rates, and with limited refining capacity outside of the United States to take on OPEC crude (and also growing U.S. exports), there are questions about whether the “system” is hitting up against a natural constraint to take on more oil supply.

Mexico is short on refining capacity considering its growing domestic demand for petroleum products, and also given its export requirements. As part of the country’s energy sector reform, gasoline prices have become deregulated. On Jan. 1, a gasoline price hike of more than 20 percent took effect and sparked popular protests. Grupo Gasolinero, the largest operator of gasoline in Mexico, stated Jan. 4 that it will be forced to close 400 of its 1,800 stations if the unrest continues.

While energy reform is likely to remain the law of the land in Mexico no matter who wins the country's 2018 presidential elections, it could face setbacks if leftist candidate Andres Manuel Lopez Obrador comes to power. However, a changing North American energy landscape, where greater integration takes shape, could help alleviate some of the issues witnessed with the rise in gasoline prices.

Delia Morris has worked in the international upstream oil & gas industry for over 13 years, and is currently Director, Global Energy Sector at Stratfor, a geopolitical intelligence firm that provides strategic analysis and forecasting services. Please contact Delia at delia.morris@stratfor.com


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