ENERGY 2,085 views

The cartel wants higher oil prices. But jawboning prices up now looks likely to flood the market further and bring about another fracker-cracking collapse. 

Oil prices are at three-month highs this morning, closing in on $49 a barrel, on optimism around OPEC’s plan to cut oil production. Don’t believe the hype. The pseudo-deal, announced at the cartel’s meeting in Algeria last week, was just an agreement to discuss the issue again in November. No quotas have yet been set. No cuts have occurred. And there’s not much propping up oil prices. Expect more whipsaws. Oil analyst Amrita Sen of Energy Aspects, in an excellent research note last week, wrote: “The market should brace itself for significant volatility, if last week is anything to go by.”

To really build constructive support under oil prices, OPEC members need to be more patient. They might enjoy the cheap sugar high of jawboning prices up with talk about cuts, but the problem is that there is so much oil sloshing around world markets right now, that even slightly higher prices will trigger even more supply, which will only knock the supports out of the market.

There’s just too much oil. World production of crude oil and other petroleum liquids is at a record high of 97 million barrels per day. That’s about 500,000 bpd in excess of demand. Which means that inventories, already in record territory at 6.57 billion barrels, will keep building.

All the big players just keep on growing. Graphic from Michael Wittner, Society Generale.

There’s plenty of market participants who could cut their output. OPEC on the whole is producing at highs above 33 million bpd. Russia (not in OPEC) is at post-Soviet highs around 11 million bpd. And the Saudis are doing 10.7 million bpd, up 1 million bpd from two years ago, when the oil bust began.

But there’s a host of OPEC countries that won’t even consider cutting back output this year because their governments are so strapped for cash they’ll sell all the volumes they can muster at any price above cash costs.

Nigeria in recent years had been producing 2 million bpd, but unrest had knocked out about 400,000 bpd of that. Now Nigerian barrels are set to return to the market.

Same with Libya, which has been struggling to export 400,000 bpd. It was doing 1.4 million bpd in 2013. News is that the Libyan National Oil Company has had constructive talks with General Khalifa Haftar and his Libyan National Army to return production. OPEC members already agreed that Nigeria and Libya wouldn’t be expected to take part in any cuts.

Basket case Venezuela has seen oil output slip from 2.3 million bpd to 2.1 million. Oil service companies have shuttered offices there, tired of not getting paid. Yet this month Caracas inked a deal with service companies including Schlumberger to boost volumes by drilling nearly 500 wells that will add 250,000 bpd eventually. Venezuela is not going to take part in a cut.

Iraq will be hard to convince as well. It has grown from 3 million bpd in 2013 to about 4.3 million, but Baghdad desperately needs cash. While Iran, having recovered to 3.6 million bpd, wants to get back to 4 million.

What about Russia? They’re set to keep growing as well. Ronald Smith, Russia oil analyst at Citigroup, wrote in the FT that Russia’s low production costs, automatically adjusting taxes and weak ruble will support further output growth of about 500,000 bpd. Wrote Smith: “Indeed, we estimate that the returns of a standard vertical well in West Siberia today are the same or even higher than what would have been earned on that same well in June of 2014 when oil was around $112 a barrel.” He sees Russian output growing slowly for the next five years.

So where’s this cut going to come from?

Just to keep production flat as Nigeria and Libya return to the market, OPEC will need to slice off 900,000 bpd from somewhere.

The Saudis have said they will not cut unilaterally. Maybe they could convince their well heeled neighbors in Kuwait, UAE and Qatar (6.5 million bpd between them) to dial it back a little. Or maybe not.

And then there’s America’s frackers. U.S. output is down about 1 million in the past year, accounting for most of the world declines. It’s only natural that low-cost OPEC barrels seize market share from America’s producers. But there are limits. The frackers have proven remarkably resilient and clever about squeezing costs and finding cheaper oil, especially in the Permian basin of Texas. After hitting a low in rig count last spring, America’s producers have added back more than 150 rigs. Goldman Sachs says get ready for U.S. output to boom anew, with the potential for frackers to add back 500,000 bpd next year. “With non-OPEC supplies already falling by the wayside, there is little rebalancing that can occur outside of OPEC,” writes Sen of Energy Aspects.

Meanwhile, global inventories just keep increasing. And demand remains anemic. Energy Aspects expects just 1.1 million bpd in increased oil demand next year, with .8 mmbpd of that coming from Asia. A slowdown in China could wipe out nearly all of that, even as China continues to buy more than 21 million new cars a year (more than the U.S.) and fill its Strategic Petroleum Reserve. According to Gabriel Collins at Rice University’s Baker Institute, the oil intensity of the Chinese economy has plummeted, from 1.7 million barrels required per $1 billion of GDP in 1995 to less than 500,000 barrels per $1 billion today. China will need ever less oil to support slower growth. Along with China, only India shows material increase in oil demand.

Screen Shot 2016-10-03 at 3.23.17 PM

The only good news for OPEC — the two-year bust has caused companies to cancel or defer $750 billion in planned capital spending between 2015 and 2020 (about 25% of total). Add in cuts to exploration and the total is more than $1 trillion in deferrals.

Eventually, slowed spending plus natural decline rates in mature fields of about 5% a year will work off the oily excesses. But not quite yet. If OPEC doesn’t figure out how to cut, (and cut more than any members of the cartel looks inclined to do) inventories will just keep on building until late 2017.

OPEC wants higher oil prices. But jawboning prices up now looks likely to flood the market further and bring about another fracker-cracking price collapse. So go ahead and buy that second SUV.

 

http://www.forbes.com/sites/christopherhelman/2016/10/04/dont-believe-the-hype-opecs-cut-will-not-balance-a-flooded-oil-market/print/